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PRACTICAL ECONOMICS 



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PRACTICAL ECONOMICS 



BY 
HENRY P. SHEARMAN 

PBOFESSOK OF ECONOMICS, DUQUESNE UNIVERSITY 



First Edition 



McGRAW-HILL BOOK COMPANY, Inc. 
NEW YORK: 370 SEVENTH AVENUE 

LONDON: 6 & 8 BOUVERIE ST., E. C. 4 

1922 



fi 



sv 



^\ 






Copyright, 1922, by the 
McGraw-Hill Book Company, Inc. 



NOV 16 ^22 






PREFACE 

The rise and rapid spread of business education which has been 
such a prominent feature of our modern educational system has 
not only resulted in a call for courses dealing with particular fields 
of business activity, ks accounting, banking and selling, but has 
considerably augmented the demand for a knowledge of the gen- 
eral theory of business as treated in the science of economics. 

From long association with business men as well as from the 
teaching and discussion of economics with students drawn largely 
from the ranks of practical men of affairs, I have been impressed 
with the insistent demand for a simpler and more concrete state- 
ment of economic theory than is usually found in the standard 
works. 

To satisfy this demand the present book has been prepared. 

No attempt has been made to depart radically from standard 
economic theory. The aim has rather been to state in simple 
language and to explain as concisely as possible, the general laws 
and principles underlying and governing the production and dis- 
tribution of wealth in the United States today, for the benefit of 
all who desire to gain a clearer understanding of the structure of 
our economic system and of the forces operating within it. In 
consideration of the increasingly important part played in mod- 
ern affairs by business organization, more attention has been 
devoted to it than has been customary; and it is treated as a sep- 
arate factor in production along with land, labor and capital. 

While of course economics is concerned with the theory of busi- 
ness and its peculiar function is to set forth the operation of those 
broad and fundamental laws governing business as a whole, special 
pains have been taken to point out their practical consequences 
in everyday business life. In other words, the connection between 
theory and practice has been kept constantly in view and wherever 
possible the practical application of laws has been pointed out by 
illustrations drawn from modern business practice. 

Furthermore, the human side of the subject has been emphasized 



vi PREFACE 

and frequent reference has been made to the bearing of economic 
laws on the personal interests of individuals whose welfare in the 
aggregate constitutes the national well-being. 

The economic problems of today have assumed such propor- 
tions as to have completely outgrown adequate treatment in an 
elementary text and are now rightly and better dealt with in 
separate treatises. No attempt has been made, therefore, to 
crowd these in, but rather to state clearly the laws and principles 
on which they rest. Here again every opportunity has been taken 
to point out the relationship between the laws discussed and the 
questions of the day upon which they bear. 

In writing on a subject which has so challenged the attention 
of thoughtful men for centuries and which already has such a 
rich literatm-e one must naturally owe much to previous writers. 
On account of their number, I regret that I must limit myself to 
a general acknowledgment of my indebtedness. To my old col- 
league Dr. Wm. M. Deviny and to Dr. Wm. H. Walker, both of 
whom read a large part of the manuscript, I tender my thanks. 
During the five years the book was in progress, very able and 
courteous service was afforded me in research and statistical work 
by the staff of the reference department of the Carnegie Library 
of Pittsburgh. 

Henry P. Shearman 
Pittsburgh, Pa. 
September, 1922 



CONTENTS 

Pkeface V 

PART I 
Explanatory and Introductory 

Chapter . Page 

I. Economics — Its Purpose and Value 3 

PART II 

An Analysis of the Basic Factors on which the Production of All 

Wealth Depends — Their Nature and the 

Causes of Their Productivity 

n. Nature as a Factor in Production — with Some Account of the 

Natural Resources of the United States 15 

III. Man as a Factor in Production 31 

IV. The QuaUties Determining the Efficiency of Labor 40 

V. The "Division of Labor." Its Advantages and Disadvantages . 50 

VI. Capital as a Factor in Production 64 

VII. The Two Important Functions Performed by Capital in Mod- 
ern Production 74 

VIII. Organization as a Factor in Production 84 

IX. Large-Scale Organization 96 

X. The Economics of Large-Scale Organization 105 

PART III 

Exchange, Values and Prices 

XI. Origin and Nature of Value 117 

XII. The Law of Demand and Supply 127 

XIII. The Forces behind Demand; the Determination of Individual 

Demand 138 

XIV. The Determination of Total Demand 149 

XV. The Forces behind Supply — Cost of Production 168 

XVI. Influence of Cost on Price 180 

XVII. Influence of Cost and Utihty on Price 192 

XVIII. The Influence of Monopoly on Price 204 

XIX. Competitive Price: Monopoly Price: Price Regulation and the 

Law of Demand and Supply 217 

vii 



viii CONTENTS 

Chapter Page 

XX. Money and Our Monetary System 223 

XXI. Deposit Currency and Banking 241 

XXII. Changes in the Value of Money or the Level of Prices and 

Their Measurement 259 

XXIII. Causes and Effects of Price Changes; and Foreign Exchange . 276 

PART IV 

An Analysis op the Four Forms of Income Through Which All Wealth 

Produced is Distributed and the Factors 

Determining Their Amounts 

XXIV. The Distribution of Wealth 293 

XXV. Rent. . '. 306 

XXVI. Wages— Factors on the Demand Side 320 

XXVII. Wages— Factors on the Supply Side 334 

XXVIII. Interest 355 

XXIX. Profit 368 

Index 383 



PRACTICAL ECONOMICS 

PARTI 

EXPLANATORY AND INTRODUCTORY 



CHAPTER I 

ECONOMICS: ITS PURPOSE AND VALUE 

DEFINITION 

In approaching a study, a definition serves somewhat the same 
purpose as a telescope in the hands of a passenger on an Atlantic 
liner; it enables him to locate and obtain a bird's-eye view of a 
distant port long before it is even visible to the naked eye. 
Although the view is of necessity compressed into a small com- 
pass, it at least affords him some idea of the location of the place 
toward which he is heading and of its main outlines. A long dis- 
tance definition of economics, or political economy as it is some- 
times termed, tells us it is that science which treats of man's 
efforts to provide himself with food, clothing, shelter, and what- 
ever else he deems essential to his welfare. Drawing a little 
closer we see that it is concerned with business activities and 
institutions. Hence it is often spoken of as the science of busi- 
ness, and if the word business is used in its broadest sense to 
cover a nation's activities in the production, exchange and distri- 
bution of wealth such a definition is both practical and sound. 

POINT OF VIEW 

The business activities of a modern nation like the United 
States comprise a miscellaneous mass of practices by means of 
which more than a hundred million people in competition and 
cooperation with each other satisfy their varied wants. Each 
individual engrossed in his own particular work and inter- 
ested in his own private ends rarely understands the working 
of the whole system of which he and his affairs occupy but 
a fractional part. In consequence his views of certain sec- 
tions of activity or of the system as a whole are apt to be warped 
by his own interests. It is precisely this deficiency that 

3 



4 . PRACTICAL ECONOMICS 

economics seeks to correct by substituting for the viewpoint of 
the private individual, the broader one of society as a whole. 
It is important to stress this feature of economics, for the 
angle from which a subject is studied makes an appreciable 
difference in one's understanding of it. The same institution or 
phenomenon observed from opposite sides may not only appear 
different in character but actually be different. Wages to the 
worker are his means of livelihood, to the employer they are 
costs; to the economist they constitute the share of the net 
product of industry paid to the worker for the part he has played 
in production. Profits to the individual business concern are the 
difference between costs and receipts; but from the viewpoint of 
society they are the amounts necessary to stimulate and insure 
business enterprise. A strike or a lockout in a given industry 
may appear to the combatants a perfectly justifiable method of 
settling a wage dispute, but to the community it may mean dis- 
comfort and even privation. An invention that throws a worker 
out of a job is a harmful thing in his eyes; to the inventor to 
whom it brings a fortune it appears in just the opposite light. 
To society it is an instrument of progress, hurtful perhaps to the 
individual worker for the time being, though beneficial to labor 
in the long run. The business corporation is to the stockholders 
a source of profit; to the economist it is the agency by means of 
which land, labor and capital are coordinated to supply the 
nations' needs. Economics studies business institutions and 
activities not solely in relation to individual or class interests but 
in their bearing on the interests of the nation at large. It stands 
as the champion of the economic welfare of the people as a whole. 

STUDIES BUSINESS AS A WHOLE 

The aggregate of business institutions and practices of a 
nation at a given time is sometimes referred to as its economic 
system. But it is evident these do not constitute a separate 
system in the sense that a government is a system with a central 
controlling head. It is possible either by revolution such as we 
have witnessed in Russia or by the more peaceful path of 
evolution, that these may become merged into one unified 
organization operating under the control of a centralized man- 



ECONOMICS: ITS PURPOSE AND VALUE 5 

agement. Such is the dream of the Socialists. But in the 
world as it is, the economic activities of each nation are car- 
ried on by a host of separate though closely related individuals 
and organizations. This vast and varied mass of institutions 
and activities is the economic system by means of which the 
wealth of the nation is produced, exchanged and apportioned 
among its members. It is the object of economics as a science, 
to study these activities as a whole in a systematic way, to 
describe them, show the relationships of the various parts. 
and the laws and principles governing them. 

RELATION OF ECONOMICS TO SPECIALIZED ECONOMIC 

STUDIES 

To explain the operation of all parts and branches of modern 
business; to describe all kinds of business organizations; to pre- 
sent the laws and principles governing manufacturing, trans- 
portation, commerce and finance; to solve the baffling problems 
arising in connection with the production, exchange and distribu- 
tion of wealth, such as the tariff, monopoly control, government 
regulation of industry, the question of labor and capital and 
so on, — would be today a stupendous task for any one science. 
When economics was in its infancy in the time of Adam Smith, 
all the known laws and principles governing business might 
have been included in one general treatise. Since that time, 
especially during recent years as a result of inductive study 
of increased statistical investigation and research, an ever 
growing body of data covering separate fields has been gathered, 
new laws and principles have been formulated and many corol- 
laries to the general laws have been added. To include these in 
one treatise is practically impossible. Since the first general 
treatise was written by Adam Smith in 1776, the present science 
has branched out. The leading universities in the United States 
and similar institutions in England, Germany and other coun- 
tries, are now teaching intensive courses in many separate fields 
of business activity. 

Of these separate subjects some, like salesmanship and indus- 
trial organization and management, are yet relatively unde- 
veloped and to a certain extent lack the broad, social viewpoint. 



6 PRACTICAL ECONOMICS 

Others like money and currency, foreign exchange, industrial 
combinations, labor organizations, etc., are in reality divisions 
of economics, being separate treatises the outcome of intensive 
study of special phases of economic activity looked at from 
the social viewpoint. 

The relation between these separate economic studies and 
economics is evident. Each of the former is confined to a specific 
sphere of business activity and aims to explain its institutions 
and activities, to discover the laws and principles governing its 
operation, whether it be selling, management, finance, or tariff 
regulations. But economics covers the whole field in a general 
way and aims to display those broad general laws and principles 
that govern business as a whole. It carries out a survey of the 
entire field in order to give a bird's-eye view and enable the 
individual to obtain a perspective of that miscellaneous com- 
plex of acitivities constituting modern business, so that what- 
ever particular branch he may study or practice later, he may 
by virtue of his broader vision sense his relation to other 
activities and his part in the whole. For this reason economics 
is sometimes spoken of as the general science of business. 

METHODS 

There are two methods of building up a science, deduction and 
induction. In the older sciences such as astronomy and mathe- 
matics the former was chiefly used, in the more modern the latter 
method, sometimes termed the Baconian method on account of 
the emphasis placed on it by Francis Bacon, is largely employed. 
In deduction, the general conclusion or hypothesis is put forth 
first and then tested out by application to particular cases. In 
induction a study is made of a particular case, as a result of 
which a general conclusion is arrived at. But in deduction the 
a priori conclusion is itself the result of a certain amount of 
observation, while in induction the selection of specific instances 
is more or less aided by preconceived conclusions. Indeed, as 
someone has aptly remarked, in the building up of any science 
bo1?h deduction and indxiction are as essential as the right and 
left foot in walking. 

In the early stages of economics, deduction played an 



ECONOMICS: ITS PURPOSE AND VALUE 7 

important part in formulating the general laws of the science but 
more recently the inductive method, especially in its statistical 
form, has been increasingly used. The growth of statistics has 
much enriched the science of economics both in the discovery of 
new laws and in the verification of the old. Whatever economics 
was in its infancy, it has taken on a very practical aspect of later 
years. Some of its early doctrines not standing the acid test of 
experience have been thrown aside; and with modern research 
and statistical investigation into actual business practices and 
facts laws and principles haA^e resulted which are forged out of 
actual practice and tested by business experience. 

AN INEXACT SCIENCE 

One of the chief charms of economics and at the same time I 
its weakness as a science lies in its very humanness. Unlike 
astronomy, physics or chemistry, it is not an^eaiofi^ science. By 
which it is meant that its laws and principles are not statements 
of relationship or movements of forces that act inevitably in a 
fixed manner and with an exactness capable of being measured 
to a fraction. The wages of labor, the upward and downward 
swings of prices, the movements of foreign exchange rates, the 
flow of gold, are governed by laws but not rigid laws like those 
that determine the movement of the stars or of inanimate matter 
in general. The astronomer is able to predict to a fraction of a 
second the appearance of a star that swings into his vision but 
once in a hundred years; the chemist knows with surety that 
whenever he mixes certain chemicals a given reaction will always 
result and he is able to measure the result quantitatively. But 
the economist because he treats largely of human forces and 
activities based on human relationships cannot predict results 
with the same sureness or measure causes and effects with the 
same exactness. He may know that the amount of a commodity 
that will be purchased will vary inversely with the price charged 
but he may not know exactly how much an increase of 25 per 
cent on the price will reduce its sale. The laws of economics, 
therefore, like those of its sister social sciences, ethics and 
politics, are not hard and fast statements of invariable facts 



8 PRACTICAL ECONOMICS 

but rather statements of tendencies admitting of numerous 
exceptions. 

The inexact and general nature of some economic laws by no 
means deprives them of their usefulness or invalidates economics 
as a science, though there is no doubt but that a lack of a proper 
understanding of this feature of the science has been a cause of 
its mis judgment. The fault lies partly with economists who 
have sometimes exaggerated the accuracy with which some of 
the more general laws operate in actual life. On the other hand, 
some of the criticism has been due to a misconception on the 
part of many practical business men as to what a science really 
is and failure to make allowance for the uncertain nature of 
the subject matter with which economics deals. 

It is natural for hard-headed business men to want laws 
capable o^ specific and immediate application to given conditions. 
Many of the rules and principles of specialized economic studies 
are of this character but many of the laws of economics are 
general in nature and call for judgment in applying them to 
concrete cases; their action is often modified by other factors 
and forces which must be taken into consideration. Moreover 
some are what might be termed long distance laws, requiring 
considerable periods of time for their operation and often their 
immediate effects are quite opposite to their ultimate conse- 
quences as in the case of the effect of machinery on labor. But 
to lay the blame of this on economics is to lay it at the wrong 
door, for the remoteness and uncertainty of its laws are not due 
to the science but to the complexity of the activities it seeks to 
explain. 

Much of the criticism launched against economics arises from 
the popular and ancient misconception of the relation between 
theory and fact which in the minds of some will always appear 
to be antagonistic. But theory in the only sense in which it finds 
a permanent place in a science must be in harmony with facts. 
In themselves, facts are valueless. What is needed is an under- 
standing of facts, of their causes and effects. Such an under- 
standing is gained by an explanation. Such an explanation is a 
theory. Of course, there are false theories but to condemn all 
theories because some are false would be equivalent to a refusal 



ECONOMICS: ITS PURPOSE AND VALUE 9 

to accept money because it is sometimes counterfeited. Yet 
there is usually some basis for popular beliefs and the origin of 
the popular susJ3icion of theory is no doubt due to this tendency 
of theory to depart sometimes from actual facts. In attempting 
to explain a given phenomenon, to find its cause a scientist will 
often start with a hypothesis or what the man in the street 
would call a guess. With this as a guide he will investigate just 
as a mechanic in trying to find what is wrong with his motor, 
after listening perhaps will conclude the trouble lies in the 
carburetor. He then tests his theory out. So also does the 
scientist, but so complicated are some of the problems of the 
scientist and so anxious is he to explain them, that he may neglect 
to test his theory sufficiently and proclaim that which is true in 
a few cases to be true universally. Or he may become so 
enamoured by his theory that he is carried away by it, fitting 
and adapting the facts to the theory instead of the theory 
.to the facts. The antagonism of the man in the street to theory 
is thus a warning against fanciful theories and too hasty general- 
ization. Economics like other sciences has doubtless been guilty 
in this respect but recently it has profited much by criticism 
and tends more and more to test out its conclusions and discard 
those which when weighed in the balance of experience are found 
wanting. 

VALUES 

In former years a knowledge of economics was mostly confined 
to those engaged in the administration of public affairs. But 
while it is evident that those directly responsible for the welfare 
of the nation should be thoroughly conversant with the laws and 
principles on which national prosperity is founded, it is not 
desirable in this democratic age that such knowledge be 
restricted to the few in the seats of the mighty, especially in 
consideration of the fact that modern politicians themselves are 
none too well versed in the science. The majority of the leading 
questions of the day, upon which decisions directly affect the 
destinies of the nation and the happiness of the people, are 
economic. Their issues are often beclouded and warped by deep- 
rooted class or local prejudice. There is needed for their con- 



10 PRACTICAL ECONOMICS 

sideration the broad social viewpoint and a clear knowledge of 
those fundamental laws governing not only domestic affairs but 
foreign trade. This knowledge should be in the possession of the 
people themselves. Any country with a large body of its citizens 
in ignorance of general economic truths on which national pros- 
perity rests is in danger of having its masses influenced by false 
propaganda and its legislation warped by special interests. The 
need for an enlightened public opinion on economic subjects was 
never more acute than today. 

Not only on grounds of public policy is a knowledge of 
economics desirable but for the sake of individual economic 
advancement. Personal experience will always be the basis of 
business ability but the influences that play upon a modern 
business extend far beyond any one man's individual experience. 
Less and less are business concerns influenced only by local con- 
ditions; more and more are they affected by world happenings. 
The narrow provincialism which has so often characterized 
American business men in the past is necessarily giving away to 
a more cosmopolitan outlook. The granting of credits by banks, 
the borrowing of funds by corporations, the purchasing of raw 
materials, the planning of selling campaigns, the extension of 
plants, the location of new factories, — all demand on the part of 
those responsible, not only a specialized knowledge of credits, 
plant management, selling, etc., but a familiarity with busi- 
ness conditions in general. The executive today needs to be 
master not merely of his particular field but of the broad fun- 
damental laws governing business as a whole. The ability to 
interpret conditions, read the signs of the times, forecast de- 
pressions or booms, price rises or falls, the effect of a tariff, 
and other economic tendencies which might wreck or further 
his plans, enables him to adjust his affairs to outside condi- 
tions in such a manner as to avoid failure and achieve suc- 
cess. What the science of navigation and a knowledge of 
undercurrents and hidden rocks of the ocean are to the cap- 
tain on the bridge of the Atlantic liner, the science of economics 
is to the executive at the helm of a business, enabling him to 
avoid the hidden shoals in the sea of business affairs. 

It has been said that while economics is essential for execu- 



ECONOMICS: ITS PURPOSE AND VALUE U 

tives or college men who later will assume positions of respon- 
sibility, it is wasted time teaching it to clerks or mechanics. 
There is an element of truth in this. A clerk does not require 
the same education as a banker. And providing the clerk intends 
to remain a clerk, a couple of courses in accounting will better 
fit his needs and bring him in the immediate remuneration which 
as a rule marks the limit of his mental horizon. Moreover, to 
attempt to load economic laws into the minds of this species of 
the clerical genus is akin to trying to put 44 caliber shells into 
a 22 rifle. Economics should, however, have a strong appeal to 
the 44 caliber man in clerical work ambitious to prepare himself 
for more important service in the future. 

One danger facing the young man entering business life today 
is its narrow specialization. Where his father started in a small 
concern in which he was able to pick up by experience a working 
knowledge of the different branches of the business, the youth 
today pigeon-holed perhaps in one department of a big corpora- 
tion finds sparse opportunity for securing that all-round training 
and broader viewpoint so necessary for executive work. While 
a study of economics alone cannot remedy this, it will materially 
help him to broaden out. His knowledge of economic laws and 
principles will give him an insight into the meaning of hap- 
penings in his own concern and the world around him which the 
man beside him will lack. He will be able to read with intel- 
ligence articles on economic subjects in the financial and business 
magazines which are unintelligible to the man in the street. In 
the office or club or on the platform, he will be better equipped to 
discuss the questions of the day. Truly, it will give him a deeper 
insight into life itself, for no study is more thoroughly enlighten- 
ing regarding human affairs than that which treats of mankind's 
struggle to make a living. 

TEST QUESTIONS 

1. What is "Economics"? 

2. From what point of view are business activities studied in economics? 

3. What is the relation of economics to the specialized business courses 
such as accounting, banking and selling? 

4. What is meant by referring to economics as an inexact science? 



12 PRACTICAL ECONOMICS 

5. What is theory? What kind of theory is referred to the state- 
ment — "The eternal conflict between theory and fact"? How can theory 
and practice be reconciled? 

6. Name some of the values to be derived from a study of economics. 

REFERENCES 

Cairnes, J. E., Character and Logical Method of Political Economy 
(Second Ed., 1845). 

Cl.\y, H., Economics for the General Reader (Chap. I). 

Ely, R. T., The Past and Present of Political Economy (Johns Hopkins 
University Studies in Historical and Political Science). 

GiDE, C. Pohtical Economy (Book II, Chap. II). 

Keynes, J. N., The Scope and Method of Political Economy (London, 
1891). 

Laughlin, J. L., Study of Political Economy. 

Marshall, A., Principles of Economics (Chap. I). 

Palgrave's, Dictionary of Political Economy, Vol. 3. 

PiERSON, N.^G., Principles of Economics (Introduction). 

Ross, E. A.. The Foundations of Sociology (Chaps. I, II). 

Seligman, E. R. a.. Principles of Economics (Chap. II). 

Smith, A., Wealth of Nations (Introductory Sketch). 

Smith, R. Mayo, Statistics and Economics (1899, Chap. I). 

WiCKSTEED, P. H., The Common Sense of Political Economy (Introduc- 
tion) . 



PART II 

ANALYSIS OF THE BASIC FACTORS ON WHICH 

THE PRODUCTION OF ALL WEALTH 

DEPENDS 



CHAPTER II 
FACTORS OF PRODUCTION: NATURE 

The primary factors in the production of wealth are nature 
and man. Nature supplies the material and forces out of which 
and by which wealth is produced. Man, the active agent, directs 
the processes of production by physical and mental effort. 
Capital, usually termed a secondary factor, because itself a 
product of nature and man, supplies the tools and goods which 
aid in further production. Organization appears as a fourth 
factor, the product of the first three, and the means by which 
they are coordinated for effective production. A clear under- 
standing of each of these factors, of the part each one plays, of 
the causes affecting the efficiency of each, and of the relationship 
existing between them, will enable us to secure a comprehensive 
grasp of the principles governing modern production. 

THE PART PLAYED BY NATURE IN PRODUCTION 

Nature or "Land" as this factor is often termed, not only pro- 
vides in the surface of the earth a solid foundation for man's 
activities but in addition is the sole source of the raw materials 
and forces used in production. From the mines of the earth 
come the metals and minerals, iron, coal, copper or petroleum, 
from the rich productive soil spring crops of cotton or corn. 
The forests furnish lumber, the rivers and lakes water. In the 
fashioning of these raw materials into objects of wealth man is 
greatly aided by forces inherent in the materials themselves. 
Modern chemistry has shown that matter is not dead but 
dynamic with latent powers. In the laboratory the industrial 
chemist experimenting with these hidden forces induces reactions 
which result in dyes, alloys, gasses, or fuels. Organic chemistry 
with the theory of valences has opened up a new world of natural 
forces which under the skillful manipulation of the chemist are 

15 



16 PRACTICAL ECONOMICS 

being used to produce products hitherto found only in a natural 
state or to create new ones better adapted to man's new needs. 
Furthermore man's own labor has been tremendously augmented 
by the employment of natural forces such as the expansive force 
of steam, the explosive force of gases and electricity. The revo- 
lution which industry has undergone in the last one hundred 
years is largely due to man's discovery and use of these powerful 
forces. The earth, the ocean and the atmosphere are the 
reservoirs of mother nature, from whose depths and heights come 
not only all the materials on which man depends for the support 
of life, but the physical, chemical and vital forces employed to 
work these into shape for the satisfaction of his wants. 

ALEXANDER HAMILTON AND THE ERROR OF THE 
PHYSIOCRATS 

The pra^ctical value of a thorough grasp of the part played by 
nature in production as well as the danger of a half knowledge 
is illustrated in the stand taken by Alexander Hamilton against 
the famous "error" of the Physiocrats. The Physiocrats, a 
French school of economists of the eighteenth century, saw the 
influence of nature in agriculture but were blind to its connection 
with manufactures. This led them to exalt agriculture at the 
expense of manufacturing which they regarded as sterile. Agri- 
culture they asserted was productive because assisted by nature 
in a special sense but manufactures not receiving this cooperation 
were unproductive. The farmer planting a seed into the soil 
reaped a hundred fold through the vital laws of growth and so 
enriched the nation, but the manufacturer who in their opinion 
merely changed the form of things added nothing to the existmg 
wealth. 

Their theories were reflected in France by the discouragement 
of manufactures through heavy taxation which was only thrown 
off by the French revolution. This same error crossing the 
Atlantic attempted to stunt the early development of manufac- 
tures in the States. At the adoption of the Constitution, this 
counry with its abundance of fertile land was particularly 
adapted to agriculture. This natural adaptation was emphasized 
by the mercantile policy of Great Britain which encouraged the 



FACTORS OF PRODUCTION: NATURE 17 

exportation of raw materials from the States, in return for 
manufactured articles. 

Many believed that the future interests of the nation would be 
best attained by keeping it an agricultual country, and they 
vehemently opposed the establishment of manufactures. In 
Alexander Hamilton's famous "Report on Manufactures" pre- 
sented to the House of Representatives Dec. 5, 1791, in which he 
argued for the establishment of industries he said: 

There are still, nevertheless, respectable patrons of opinions un- 
friendly to the encouragement of manufactures. The following are 
substantially, the arguments by which these opinions are defended. 
"In every country," say those who entertain them, "agriculture is 
the most beneficial and productive object of human industry. This 
position, generally if not universally true, applies with peculiar empha- 
sis to the United States on account of their immense tracts of fertile 
territory, uninhabited and unimproved. Nothing can afford so advan- 
tageous an employment for capital and labor as the conversion of this ex- 
tensive wilderness into cultivated farms. Nothing equally with this can 
contribute to the population, strength and real riches of the country." 

It has been maintained that agriculture is not only the most produc- 
tive but the only productive species of industry. The reality of this 
suggestion, in either respect, has, however, not been verified by any 
accurate detail of facts and calculations, and the general arguments 
which are adduced to prove it are rather subtle and paradoxical than 
solid or convincing. 

It was well for the future of the nation that its destinies were 
guided in this formative period of its existence by so shrewd a 
thinker and practical a statesman as Alexander Hamilton, who 
saw through the error which distorted the vision of others. 
There is no doubt that industry would ultimately have forged 
ahead, but had it been exposed in its infancy to the frosts of 
external and the forces of internal opposition, its growth must 
have been retarded. The extraordinary rapidity which has 
marked the development of manufactures and the consequent 
rise of the United States to its present commanding position 
among the nations is due in no small measure to the farsighted 
economic policies of Alexander Hamilton. It is again imperative 
that the nation should see clearly the relationship of nature to 
her industries. 



18 PRACTICAL ECONOMICS 

THE IMPORTANCE OF A WISE CONSERVATION OF 
NATIONAL RESOURCES 

It is a peculiar paradox of modern life, that while man's 
dependence on nature is increasing, through his ever increasing 
wants, his sense of dependence on nature is decreasing. Living 
in big cities, working day by day in manufacturing plants, far 
removed from the sources of the materials he is using, it is little 
wonder that he scarce gives a thought to their origin. So busily 
engaged is he in earning and consuming his share of the proceeds, 
that he seldom pauses to consider whether the original sources 
of supply are exhaustible or not. It is not a subject that appeals 
spontaneously to the average individual though it concerns him 
more closely than he imagines. The conservation of natural 
resources is essentially an economic question for the considera- 
tion of the whole nation. Each country inherits a certain limited 
stock of natural resources, which once gone can never be 
replaced. The nation which neglects to take stock of these 
resources is in the position of a man who inherits a bank account 
and in spending it fails to keep track of the balance. It is easy 
to overdraw. The significance of certain well attested facts 
regarding the rapid rate of consumption of some of the principle 
resources of the United States seems to call for a national stock- 
taking. It is high time to bring the subject of conservation to 
the foreground of national consciousness. A back-to-nature 
movement in economic thought would exert a wholesome 
influence on the nation. A deeper realization by the producers 
of the nation of their ultimate dependence on the natural 
resources of the country, would tend to check needless waste and 
to encourage a wise conservation of those resources. Its con- 
sideration requires a certain loftiness of purpose and farsighted- 
ness of vision, embracing as it does, not only the welfare of the 
millions of today, but of generations unborn. 

RENEWABLE AND NON-RENEWABLE RESOURCES 

For the purposes of conservation, natural economic resources 
may be divided into renewable and non-renewable. The waters, 
the forests and the soil constitute the former. These may be 



FACTORS OF PRODUCTION: NATURE 19 

retained in their original quantities and even improved by wise 
use. A good farmer on retiring leaves his farm in better con- 
dition than when he began its cultivation. The non-renewable 
resources consist of the fuels, metals and chemicals; once taken 
from the ground they cannot be replaced. The purpose of con- 
servation is to maintain the renewable resources in an undimin- 
ished state and to utilize the non-renewable resources with the 
greatest economy. It is outside the scope of the present chapter 
to make a complete survey of the resources of the United States. 
A brief presentation of the facts in reference to two or three of 
the principal resources will reveal their basic relationship to the 
industrial prosperity of the nation. 

The custom of the United States from its inception until very 
recently has been to keep its gates wide open to the rest of the 
world, giving freely of its land and resources to all who sought 
citizenship. In times gone by it seemed that those resources were 
unlimited. Today, owing to the remarkable growth of its popu- 
lation from a paltry four million in 1790 to more than a hundred 
million, it finds itself in a very different situation. 

THE DEPLETION OF FORESTS IN THE UNITED STATES 

The original forests covered not less than 100,000,000 acres 
containing 4,800,000,000,000 feet of merchantable timber. About 
half of these forests have gone. The number of feet cut rose 
from 18,000,000,000 in 1880 to 34,000,000,000 in 1905; doubling 
in twenty-five years. We take from the forests each year, not 
counting the loss by fire, three and a half times their annual 
growth. Other countries have been forced to conserve their 
supply. Germany spent $80,000,000 in one year on the preserva- 
tion of her forests, and at the beginning of the war her annual 
growth was fast approaching the annual cut. China has paid no 
attention to her forest problem, with the result that her once 
extensive forests are practically gone. Japan has 59 per cent of 
her total area under forests. The United States forest service 
declares that under right management our forests will yield over 
four times as much as now. We shall suffer for timber to meet 
our needs until our forests have had time to grow again. But if 



20 PRACTICAL ECONOMICS 

we act vigorously and at once we shall escape permanent timber 

scarcity. 

LOSSES BY SOIL EROSION AND SOIL EXHAUSTION 

Uncle Sam no longer has a farm for every one. Unsettled land 
there still is, but little fitted for agriculture. The end of free 
land is in sight. The rapidly increasing population has prac- 
tically absorbed the available spare land. It is now a question 
of maintaining the productive power of the soil in an undimin- 
ished state, that it may feed the ever-increasing population. 
The two causes of waste of land are erosion and soil exhaustion 
by wrong methods of cultivation. The former acts by washing 
away the fertile surface of the soil into the streams which sweep 
it onward to the seas. The annual estimated loss by erosion is 
783,000,000 tons, or 610,000,000 cubic yards of surface soil. By 
deep tillage and surface protection through planting, much of 
this loss may be prevented. 

The ruinous waste through soil exhaustion due to single crop- 
ping or insufficient fertilization which has characterized farming 
in this country in the past, has resulted in a lessening of the pro- 
ductive powers of large areas of land. James J. Hill in an address 
delivered at the White House conservation conference in 1908, 
said, after quoting statistics showing the decrease in the yield of 
wheat in the previous ten years in the states of New York, 
Kansas, and Minnesota: 

We perceive here the working of a uniform law independent of loca- 
tion, of soil or of climate. It is the law of diminishing return due to 
soil destruction. Apply this to the country at large, and it reduces 
agriculture to the condition of a bank whose depositors are steadily 
drawing out more money than they put in. What is true in this in- 
stance is true of our agriculture as a whole. In no other important 
country in the world except Russia, is the industry that must be the 
foundation of every state at so low an ebb as in our own. 

INTENSIVE CULTIVATION OF FARM LANDS 

The history of all nations shows that in the early undeveloped 
period of national existence when land is plentiful wasteful 
methods prevail and are even economically advisable. It was so 



FACTORS OF PRODUCTION : NATURE 21 

in the early history of this country. The day has arrived for 
intensive methods of cultivation. Splendid work is being done 
toward this end by the Department of Agriculture, the various 
state agricultural departments, and colleges. Opposed to the 
law of diminishing returns due to soil exhaustion are the efforts 
of these bodies of scientific men. Better methods of cultivation, 
richer fertilizers, improvements in plants and grains, invention 
of labor-saving machinery, due to the application of science to 
industry, these with the education of the farmer to more careful 
and intelligent effort, will not only maintain but add to the 
productive power of the soil. Of all resources the soil is the most 
necessary. On it man depends for food and raiment, on the 
produce of the land all industry is based. 

THE FACTS IN REFERENCE TO THE COAL SUPPLY OF 
THE UNITED STATES 

In the dense swamps of the carboniferous age millions of years 
ago, nature began the manufacture of fuel for man. Deep pressed 
between the strata of the earth it has been in process of forma- 
tion for countless ages. The early settlers who cleared the 
primeval forests to make their homes and farms little dreamed of 
the fuels and metals beneath their feet which were to play such a 
vital part in building up the new world. At the adoption of the 
Constitution in 1789 anthracite coal was looked upon as so 
much useless black stone, and the vast stores of bituminous coal 
lying in nature's subterranean storehouse were unknown. Prac- 
tically none of the supply was touched for the first quarter of a 
century. The total amount used up to 1845 was 27,700,000 tons. 

THE RAPID RATE OF INCREASE IN ITS CONSUMPTION 

With the rise of the age of steam, and its insatiable hunger for 
coal, the figures tell a different tale. In 1846 5,000,000 tons were 
mined; in 1875 the tonnage had risen to 52,000,000; in 1900 to 
270,000,000 and by 1907 it had reached 480,000,000. The start- 
ling fact brought out by these figures is not the amount con- 
sumed, but the extraordinary rate of increase of consumption. 
The increase of consumption alone of the year 1913 over the year 



22 PRACTICAL ECONOMICS 

1910 was 130,000,000; more than four times the whole production 
of coal up to 1845. It has been estimated that at the present rate 
of increase the production in 1927 will be 1,800,000,000 tons and 
in 1937 over 3,500,000,000 tons. The United States Geological 
Survey estimates the amount of coal within 3,000 feet of the sur- 
face to be 3,538,554,000,000 short tons. All estimates of the 
probable length of life of the coal supply are liable to error; 
better methods of mining, revolutionizing inventions may eke it 
out beyond expectation. M. R. Campbell of the United States 
Geological Survey, in discussing the probable life of the coal 
fields of the United States, estimates that if the production were 
to remain the same as in 1913 the total coal reserves would last 
4,000 years, but if the rate of increase of the past few decades 
continues until coal is exhausted its life would be only one hun- 
dred years. In summing up, he says: 

Although by every reasonable estimate the ultimate exhaustion of 
the coal reserves of the United States appears to be an event so far in 
the future that it need concern this generation but slightly, the fact 
must be remembered that the bulk of coal being mined today is the 
best in the country and that before long, perhaps within fifty years 
much of the high rank coal will be exhausted. 

Long before that time, however, the coal shortage will cast its 
shadow before it in the shape of higher prices. It has been esti- 
mated that because of the progressive exhaustion of American 
coal fields the consumer is paying 10 per cent to 15 per cent more 
than if the supply were unlimited. 

CONSERVING THE SUPPLY BY BETTER METHODS 
OF MINING 

The right of the present generation to the use of a reasonable 
amount of coal is, of course, unassailable. It is the heritage of 
the nation and as such should be preserved for as many genera- 
tions as its economical utilization will allow. Its conservation 
resolves itself into the elimination of waste. One of the most 
flagrant sources of waste has been in mining. The geological 
survey estimates that in mining practice about one ton of coal is 



FACTORS OF PRODUCTION: NATURE 23 

lost for every two tons mined. It has been stated that of the 
total quantity of coal produced for commercial purposes since 
mining began, amounting to over 5,000,000,000 tons, at least an 
equal amount has been left in abandoned mines and irretrievably 
lost. A further source of waste connected with mining is in the 
production of slack. At the pit mouth thousands of tons have 
been burned. These wastes are being reduced through better 
methods of mining and the invention of furnaces burning slack 
as fuel. 

CONSERVING THE SUPPLY BY INVENTIONS THAT 
ECONOMIZE ITS USE 

Much of the loss in this direction is being retrieved by inven- 
tion. The making of coke in beehive ovens is a reckless waste of 
coal. One authority has estimated that the waste due to bee- 
hive ovens in West Virginia alone in six months would amount 
to 10,000,000. The replacement of these by the by-product coke 
ovens, which not only waste less coal, but also produce valuable 
by-products, is helping to conserve the coal supply. It is said 
that 8 per cent of the coal used in the production of power, light, 
and heat, or 20,000,000 tons, is going up the chimneys each year 
in smoke. To prevent this waste would be not only to save coal, 
but human lives. The pollution of the atmosphere by factory 
fumes in our big industrial centers is a contributory cause 
of lung disease. The gas engine is much superior in efficiency 
as a burner of coal to the steam engine. Wherever gas en- 
gines are used the consumption of coal is almost cut in half. 
In the making of electricity not much more than one per 
cent of the energy of coal is transformed into light. The 
substitution of water power for coal in the heating and light- 
ing of cities has effected, and will effect, an enormous saving 
in coal. Over 30,000,000 horsepower are going to waste in 
our streams every day, most of which can, and will be utilized, 
replacing coal. The development of water transportation will 
also tend to conserve the coal supply. Enough has been said to 
point out the tremendous saving possible by the elimination of 
waste in the mining and use of coal, and to suggest the means by 
which that saving may be effected. 



24 PRACTICAL ECONOMICS 

THE IRON RESOURCES OF THE UNITED STATES 

This has been called the age of iron. The structure of our 
modern civilization is built of iron. Our factories, buildings, 
machines, transportation systems, are all based on iron; our 
fabrics, clothes, and food could not be produced without it. Of 
all the metals iron is the most useful. Iron and coal are the 
material foundation of our national prosperity. During the last 
one hundred and fifty years, our industrial system has been 
forged out of iron with the use of coal. 

THE FIGURES FOR SEVENTY YEARS 

The United States has been producing pig iron during the last 
few years at the rate of about 30,000,000 tons a year; in 1916 it 
mined 35,p00,000 tons; more than two and a half times the 
amount produced by Great Britain and nearly half as much as 
the rest of the world put together. In 1775 little iron was used. 
The per capita production in 1850 was 50 pounds; in 1880, 313 
pounds; in 1908, 600 pounds. Up to 1906 the total amount of 
iron ore mined in the United States doubled every seven years. 
It was less than 12,000,000 in 1893; over 24,000,000 in 1899; 
47,000,000 in 1906 and 52,000,000 in 1907. In the decade ending 
1909 more than half of all the ore ever mined in the United 
States was extracted. Here again the ominous thing is the rapid 
increase of consumption. 

AN EXPERT OPINION 

The report of the national conservation commission. Senate 
Document 676, in discussing the probable life of the iron ores of 
the United States, sums up its conclusions in the following sig- 
nificant words: 

If the average rate of increase by decades, 108.7 per cent should be 
continued it would require the production in the next three decades of 
6,088,000,000 tons. But the ore supply now available in the United 
States is estimated at 4,788,000,000 tons which is only 78 per cent of 
the amount needed on this assumption. It is evident therefore that 
the present average rate of increase in production of high grade ores 
can not continue even for the next thirty years and that before 1940 



FACTORS OF PRODUCTION: NATURE 25 

the production must already have reached a maximum and begun to 
decline and a very large use must be made of low grade ores not now 
classed as available. The second condition with its consequent greatly 
increased cost of iron, is the only thing which can prevent a decline in 
the iron industry, measured by the amount of pig iron produced, within 
the next thirty years, unless there is in the meantime very greatly 
increased importation of foreign ores. 

Thirty years is but a moment in the life of a nation. The 
bare possibility of an iron famine demands the strictest econ- 
omy. This the big corporations, who own the ore deposits in 
the Lake Superior regions fully realize, and in consequence 
they are mining them with great care. New deposits will 
doubtless be discovered. Stone and cement will be substituted 
for iron wherever possible. Ores of lower content will come 
into use and the home supply will be eked out by imported 
ores from Brazil and Cuba. All that is possible to be done 
will be none too much, for though man can do many things he 
cannot make iron ore, and the nation's heritage of coal and 
iron though generous is far from unlimited. What is true of 
coal and iron is true of the minerals as a whole. The same 
waste in mining and use has marked the past; the same rapid 
increase in their production mark the present, the same limita- 
tion of supply looms up in the future. 

PRACTICAL CONCLUSIONS SUGGESTED BY THE 
FOREGOING STATISTICAL SURVEYS 

Three striking facts stand out clear and sharp against the 
background of this great question: 

First, the dependence of our industrial system on nature as its 
source of supplies. 

Second, the sudden and unprecedented increase during the last 
fifty years in the rate of consumption of natural resources. 

Third, the unmistakable appearance of the limited extent of 
the most essential of these resouces. 

These facts cry out first and foremost for concerted action on 
the part of government and people for the elimination of all 
waste. As we measure the life of nations the United States is in 
its infancy. It is vital for the safety of its future prosperity that 



26 PRACTICAL ECONOMICS 

the present generation of producers be trained to a wise economy 
in the use of the resources on which that prosperity depends. 

THE HOPE OF THE FUTURE LIES IN SCIENCE 

There is, however, another side to this question which perhaps 
is not so obvious. While we bear in mind the limited extent of 
the resources on which our present economic prosperity depends, 
we should not forget that nature herself is unlimited. If the eco- 
nomic history of the last one hundred and fifty years has taught 
us anything, it is that the part that nature is willing to play in 
production is only limited by the ability of the scientist to dis- 
cover her hidden powers and the genius of the inventor to apply 
them. What is really limited is human knowledge at any one 
time. Just as in traveling the horizon recedes as we advance, so 
does the apparent limit which nature imposes on the economic 
progress of any one age gradually move forward, revealing as it 
advances the wonders of the new age. As steam was the wonder 
of the last age, electricity is the marvel of this. In the last hun- 
dred years the discoveries of science and invention have suc- 
ceeded each other in rapid succession, revolutionizing our entire 
social and industrial system. What new powers and properties 
of matter will be discovered in the next one hundred years are 
only to be conjectured. Nature is an unknown quantity in pro- 
duction. If coal and iron should eventually fail, our hope lies in 
the ability of science and invention to find in the mysterious 
realms of nature even more useful substitutes. A wise conserva- 
tion of present resources, coupled with an active encouragement 
of industrial science and invention, will assure to the United 
States a continuation of that development which has almost 
overnight placed her in the forefront of the nations of the world. 

BRIEF SURVEY OF CHIEF RESOURCES OF THE 
UNITED STATES 

The following chart presents a birdseye view of the relative 
position of the United States in respect to some of the most im- 
portant mineral and agricultural products. The production of 
the United States in each case is compared to that of the next 
producing country or countries. 



FACTORS OF PRODUCTION: NATURE 



27 



In 1920 the United States produced 89,100,000 tons of Penn- 
sylvania anthracite and 556,563,000 tons of bituminous coal. 
The world's output of coal in 1920 was 1,300,000,000 metric tons, 
of which the United States produced 45.1 per cent, or 645,663,000 
short tons. Germany came next with a production of 267,838,000 
short tons. Great Britain mined 258,720,000 tons. The con- 



Coal 
1920 



Pig Iron 
1920 



Steel 
1320 



Copper Petroleum Corn 



1920 



1920 



1920 



Cotton 
1919 



J3 X5 



Fig. 1 



Wheat 

Average 

1909 to 

1913 



sumption of coal in 1920 has been estimated at 490,000,000 tons, 
an increase of 10,000,000 tons over that consumed in 1919. The 
United States exports of coal in 1920 amounted to 39,215,030 
long tons. 

The iron ore output of the United States in 1920 was 67,773,000 
gross tons, 86 per cent of which was produced by the Lake Su- 
perior district. Exports of iron ore from the United States in 
1920 amounted to 1,145,037 gross tons, imports equaled 1,268,536 



28 PRACTICAL ECONOMICS 

tons. The world's supply of iron ore has been estimated ' at 
14,310,000,000, which on the basis of a pig iron production of 
70,000,000 tons a year would be sufficient to last more than two 
hundred years. This is much a matter of conjecture. Important 
deposits have recently been found in South Africa, Australia, 
India, China, Korea, and Japan. The resources of the continents 
of Africa, Asia and Australia are not by any means known. 

In 1920 the United States produced 37,520,495 metric tons of 
pig iron, almost half the output of the whole world. In the 
manufacture of steel the United States again leads the way with 
a production of 42,811,274 tons in 1920. Great Britain's output 
was 9,202,614; no reliable figures are available for Germany. In 
1913 the United States contributed ' 46 per cent of the pig iron 
output of the five chief producing countries of the world. In 1919 
its proportion rose to 64.4 per cent and to 66.8 per cent in 1920. 
In steel its percentage of the total in 1913 was 47.6, rising to 66.1 
per cent in 1919 and to 66.6 per cent in 1920. The exports of 
steel from the United States in 1920 averaged 400,000 per month. 
Prior to the war Germany exported more steel than any other 
country. Her exports in 1913 averaged 47,900 per month, while 
the United Kingdom's exports were 411,000 and those of the 
United States 241,000. In 1919 Germany's monthly average had 
declined to 10,300, the United Kingdom's to 185,000, while that 
of the United States had increased to 362,000. 

The world's production of copper in 1920 was 949,015 metric 
tons, 548,418 tons of which was produced by the United States. 
Chile and Japan come next with outputs, respectively, of 94,531 
and 65,554 tons. The consumption of new refined copper in the 
United States during 1920 was 1,053,838,558 pounds, compared 
with 914,471,572 pounds in 1919. The United States exports of 
copper in 1920 were 553,070,086 pounds. 

The world's marketed production of crude petroleum in 1920 
totaled 694,790,251 barrels, of which 443,402,000 flowed from the 
soil of the United States. The second largest producer was 
Mexico, with an outflow of 163,540,000 barrels. The total do- 
mestic production plus imports amounted to 549,577,000 barrels. 

' F. H. Hatch, Loyidon Times Trade Supplement, Nov. 1920. 
"Iron Age, Jan. 6, 1921. 



FACTORS OF PRODUCTION: NATURE 



29 



The United States consumption of petroleum was 531,186,000 
barrels. 

The foregoing brief summary suggests the relative richness of 
the United States among the nations of the world in the posses- 
sion of the most important minerals of modern times. In respect 
to agricultural advantages she is also much to be envied, as the 
figures on the chart for corn, cotton, and wheat indicate. The 
following table, based on figures taken from "The Statistical 
Abstract of the United States," demonstrates the remarkable 
growth of this nation in the last fifty years in the development of 
her vast mineral and agricultural resources. 

Table I. — Rapid Growth of the United States in the Development of 
Its Mineral and Agricultural Resources in the Last Fifty Years 



Year 


Farm 
Animals 


Wheat 


Corn 


Cotton 


Coal 


1870 
1880 
1890 
1900 
1910 
1920 


25,484,100 
33,258,000 
52,801,907 
43,902,414 
61,803,000 
63,369,000 


bushels 
235,884,700 
498,549,868 
399,262,000 
522,229,505 
635,121,000 
787,128,000 


bushels 
1,094,255,000 
1,717,434,543 
1,489,970,000 
2,105,102,516 
2,886,260,000 
3,232,367,000 


bales 
.4,024,527 
6,356,998 
8,562,089 
10,123,027 
11,608,616 
12,987,000 


long tons 
29,496,054 
63,822,830 
140,866,931 
240,789,310 
447,853,909 
576,431,250 



Iron Ore 



long tons 
3,031,891 
7,120,362 
16,036,043 
27,554,161 
56,889,734 
69,558,000 



Pig Iron 


Copper 


tons 


long tons 


1,665,179 


12,600 


3,835,191 


27,000 


9,202,703 


115,966 


13,789,242 


270,588 


27,303,567 


482,214 


36,925,987 


539,759 



Petroleum 



barrels 
220,951,290 
1,104,071,166 
1,924,590,024 
2,672,062,218 
8,801,404,416 
18,622,884,000 



Total Minerals 



value in dollars 

218,598,994 

364,928,298 

606,476,380 

1,107,031,392 

1,991,216,220 

6,707,000,000 



Year 



1870 
1880 
1890 
1900 
1910 
1920 



30 PRACTICAL ECONOMICS 

TEST QUESTIONS 

1. Name the four factors responsible for the production of wealth. 

2. What part does nature play in production? 

3. What was the "error of the Physiocrats"? 

4. In estimating the length of life of a natural product such as coal or 
iron, of what significance is the increased rate of consumption? 

5. What is the relation between the national resources and national 
wealth ? 

6. What is the situation today in the United States in reference to her 
supplies of lumber, coal and iron for future use? 

7. Why is a wise conservation of natural resources advisable as part of 
the economic policy of the United States? 

REFERENCES 

Carver, T. N., Principles of Economics (Chap. XII). 

Clay, H., Economics for the General Reader. 

CoMAN, K., Industrial History of the United States. 

Cronan, R., Our Wasteful Nation. 

Ely, R. T., Foundations of National Prosperity. 

Ely, R. T., Outlines of Economics. 

Hill, J. J., Highways of Progress. 

Hopkins, Our Country and Its Resources. 

Marshall, A., Principles of Economics (Chaps. II, III, Book IV). 

Nicholson, J. S., Principles of Political Economy (Vol. I, Book I, Chaps. 

II and IV). 
Seligman, E. R. a.. Principles of Economics (Chap. XX). 
Seager, H. R., Principles of Economics (Chaps. Ill and VIII). 
Tarr, Economic Geology of the United States. 
Van Hise, C. R., The Conservatory of Natural Resources. 
Report, National Conservation Commission, 1909. 
Statistical Abstracts of the United States. 
U. S. Industrial Commission Report, 1902, X and XIX. 



CHAPTER III 
MAN AS A FACTOR IN PRODUCTION 

Man is the alpha and omega of economic activity. By his 
labor he sets in motion and directs the processes of production 
which result in the creation of utilities in economic goods. By 
the satisfaction of his wants in consumption he destroys these 
utilities. We will now consider the part man's labor plays in 
creating these utilities. 

MAN THE ACTIVE AGENT IN THE PRODUCTION 
OF WEALTH 

We have said that the industrial prosperity of the nation is 
based on natural resources. It is evident, however, that nature 
does not supply those resources in such manner as fully to satisfy 
man's wants. At favored localities in the tropics, nature may have 
furnished barbaric man with sufficient to satisfy his simple wants, 
in return for little labor. In colder regions it always required hard 
work on the part of man to provide food, clothing, and shelter; 
and in modern civilization the crude materials of nature fall far 
short of satisfying his varied and cultivated tastes. 

Today the finished product is far removed from the raw 
material out of which it was made. A derby hat does not remind 
us of a rabbit any more than a plate glass window suggests 
sand; or steel, red ore dust. Materials gathered from widespread 
sources enter into their composition in the course of production 
and in the numerous processes through which they pass many 
kinds of labor cooperate to effect their final transformation. 
While nature lays the foundation for production, it remains for 
man to erect the building. She may furnish the iron ore and the 
sand, but he must find them, discover their uses, and invent ways 
of making them into steel and glass. 

31 



32 PRACTICAL ECONOMICS 

THE FOUR PARTS PLAYED BY LABOR IN OUR 
INDUSTRIAL SYSTEM 

When man obtained his supplies from wherever he happened 
to be and worked them up himself with the aid of a few rude 
tools, the part that labor played in the process, though all-im- 
portant, was simple and direct. The relation of labor to modern 
production is not so simple. Some of the most vital questions of 
the day grow out of the relationship of labor to production, and 
their solution demands a clear understanding of the nature of the 
services performed by labor in our present complex industrial 
system. The product which was formerly completed by the labor 
of one man producing in small quantities for himself is now 
made in large quantities by the combined labor of many, each 
contributing only a small part of the labor necessary to the total 
production. With the money he received for his labor, he buys 
products which represent the combined labors of numerous other 
men. Commodities are not produced by individuals working 
separately, but through organized effort. They are not produced 
directly by hand, but by machinery which must itself be made. 
This involves long-time, indirect processes, and a complicated 
system of exchanges. In this transformation of natural resources 
into finished products, under the present large-scale, organized 
capitalistic system of production the function of labor may be 
divided into four stages. There are four acts in the drama of 
production and in each man assumes a different role. 

THE LABOR OF PURE SCIENCE— MAN AS A DISCOVERER 
OF NATURAL PRODUCTS AND FORCES 

Production begins with the discovery of the forces and prop- 
erties of matter and a knowledge of the laws which govern their 
use. The manufacture of stone implements by primitive man 
began when he found out the hardness and sharpness of broken 
stone. Later the discovery of fire and metals increased his pro- 
ductive power. The history of the industrial progress of the race 
is largely on account of man's discoveries of new natural forces 
and resources. The age of stone was followed by the age of 
bronze, which in turn gave place to the age of iron. 



MAN AS A FACTOR IN PRODUCTION ■ 33 

For thousands of years coal lay useless in the earth. Its dis- 
covery as a fuel, coupled with a knowledge of the power of steam, 
marked a new industrial era. Man's gradual mastery of the laws 
governing the action of these materials and forces has been the 
primary cause of his advancement in the arts of industry. 

No doubt man's early discoveries were the results of chance 
and accident. By chance he found that certain stones when 
struck emitted a spark and so would produce fire at will. By 
accident he found new seeds and roots were edible and added to 
his food supply, as later Sir Walter Raleigh added to the menu 
of Europe when he introduced the potato from North America. 
By accident the native of Brazil found the juice which oozed 
from the India Rubber tree and used it to protect himself from 
tropic showers or to play ball with on the sands of the Amazon. 
The early knowledge of mankind was the result, for the most 
part, of random thinking or haphazard experiment. 

Although in the most remote times he utilized chemical action 
in the extraction of metals and in the arts of tanning and dyeing, 
there is no evidence to show that there was any real knowledge 
of the nature of the processes involved. Up to the seventeenth 
century little was known about chemical forces. The old alche- 
mists were absorbed in their search for the philosopher's stone, 
which they fondly believed would turn the basic metals to gold. 
With the discovery of the laws governing chemical combinations 
by John Dalton in 1808, and the theory of valences by Frank- 
land and the work of Lavoisier and others, the basis of modern 
chemistry was laid. Haphazard thinking and experimentation 
gave place to scientific research, and man gained an insight into 
the forces and properties of matter which has opened up a new 
world for him. The services of the chemist to modern industry 
can scarcely be estinjated. There is hardly any branch of in- 
dustry which has not benefited by his labor; out of waste he 
brings profit; from coal tar he extracts dyes, drugs, oils, per- 
fumes as a conjuror produces rabbits from a silk hat. If the 
natural supply of an article fails, the chemist makes it synthet- 
ically. The laboratory has become an invaluable department 
in the modern plant. 

In the same way other sciences are exploring nature's powers 



34 PRACTICAL ECONOMICS 

and are bringing to light new wonders. Over two thousand years 
ago men knew that amber and jet when rubbed possessed the 
power of attracting fragments of straw, leaves, and feathers. 
But it was not until Gilbert laid the foundation of modern 
electric and magnetic science on the true experimental and in- 
ductive basis, that production was furnished with a new source 
of power. The labors of Gilbert, Volta, Faraday, Clerk Maxwell, 
and other scientists, into the nature of that mysterious and ver- 
satile force we call electricity, have paved the way for the 
revolutionary changes which have been wrought in industry by 
its diversified application. The scientist plays the leading part 
in the first act of the drama of production. He it is who does 
the pioneer work, exploring the hidden recesses of nature for new 
materials and powers. With microscope and test tube he pene- 
trates in,to the heart of things, analyzing, experimenting, measur- 
ing, recording, that those who follow him may be equipped with 
the accurate knowledge necessary for efficient production. 

THE LABOR OF INVENTION— MAN AS AN INVENTOR OF 
MACHINES AND PROCESSES FOR THE UTILIZA- 
TION OF NATURAL RESOURCES 

The second stage of production consists in the application of 
the discoveries of science to the arts of industry, by the invention 
of machines and processes. Here the inventor plays the leading 
part. The scientist discovers the laws governing the action of 
steam, gases, and electricity; the inventor harnesses them to 
machines to perform the work of industry. After the Gilberts 
and the Voltas come the Bells and the Edisons, who carry a 
stage further the labor of the pioneers. The genius of the in- 
ventor devises the means whereby this versatile power transmits 
the human voice along the copper wire from continent to con- 
tinent; heats our furnaces; lights our darkness; whisks us to the 
top of our tall buildings; drives the machinery in our plants; 
pulls our trains over the mountains ; or cures our diseases. After 
Hertz ascertains that electric waves travel through the ether 
Marconi invents the wireless telegraph to transmit messages 
across the seas. 



MAN AS A FACTOR IN PRODUCTION 35 

Not only does invention aid industry by furnishing the ma- 
chinery to make effective the powers of nature, but by devising 
new processes and combinations of matter. The scientist dis- 
covers the existence of chemical affinity and the laws governing 
chemical compounds; the industrial chemist puts these to use, by 
inventing improved processes for the reduction of ores ; for mak- 
ing steel, varnish, yeasts, gases, oils, fuels, and a thousand other 
things. If the manufacturer requires a metal of a certain light- 
ness, hardness, toughness, conductivity, the metallurgist invents 
a new alloy. The application of the discoveries of pure chemistry 
to the practical problems of manufacturing is achieving wonder- 
ful results in the elimination of waste and in increasing com- 
mercial efficiency. In the realm of biology the laws governing 
evolution and heredity have been used by agriculturists to pro- 
duce new varieties of plants and animals better suited to the 
needs of man. If the high winds on the Kansas plains destroy the 
farmers' wheat, the experts of the Department of Agriculture 
produce a new variety with a wiry stem able to withstand the 
storm. By improved agricultural processes and fertilizers the 
yield of some lands has been doubled and trebled and the average 
yield of the whole increased. 

THE COORDINATION OF SCIENCE AND INVENTION 
PROMOTES PROGRESS 

Science and invention act and react on each other. Before 
the printing press the greater part of the knowledge of one gen- 
eration was buried with its bones. The labor of Caxton provided 
the world with a means of recording its discoveries, so that now 
knowledge grows from age to age with cumulative force and each 
new generation is endowed with the wisdom of past ages and 
starts its labors where they left off. By the inventions of modern 
transportation and communication knowledge is flashed from 
one part of the world to another. This rapid interchange of ideas 
speeds up progress. The nation turns over its mental capital 
oftener. The results of scientific research quickly materialize 
into invention and invention is speedily utilized in industry. The 
different stages in the progress of production are being linked 
more closely together. The long intervals between the acts are 



36 PRACTICAL ECONOMICS 

being shortened, advancement is more rapid. The industrial 
revolution of Great Britain is evidence of the remarkable accel- 
eration of industry due to the rise of science and invention. Ger- 
many's rapid ascent from a second-rate to a first-rate power in the 
last fifty years was brought about by its thorough development 
of scientific research and invention and their close application 
to its industries. The progress made in the later stages of pro- 
duction is largely dependent on the foundation work performed 
by the scientist and inventor. This fact modern business is 
recognizing, with the result that the scientist and inventor are 
actively cooperating in our big plants in the production of 
commodities. 

THE LABOR OF ORGANIZATION AND MANAGEMENT^ 

MAN AS AN ORGANIZER AND DIRECTOR 

OF INDUSTRY 

The work of science and invention, though of fundamental 
importance, is but preliminary to the actual making of the prod- 
uct. It is one thing to invent, it is another successfully to manu- 
facture and sell that invention or the product made by it. The 
production of any commodity today is a complex undertaking, 
requiring not only the knowledge of science and invention, but 
ability to organize and direct on a large scale all the factors of 
production. In order that the discoveries of science and inven- 
tion may materialize into commodities or services, the organizing 
genius of the entrepreneur is necessary. When the craftsman 
worked in his own home, with simple tools, supplying his own 
small capital, producing for a local market, the part that organi- 
zation and management played in production was comparatively 
small. Under our present large-scale system of production, with 
its intricate division of labor, involving an extensive labor force, 
expensive machinery, factory buildings, big capitalization, vol- 
ume production for a world market, organization and manage- 
ment play an indispensable part. 

This dual function of labor is sometimes performed by two 
separate individuals or groups, in which case one group of men 
perform the work of organization, after which others step in and 
carry on the work of direction. More often both functions arc 



MAN AS A FACTOR IN PRODUCTION 37 

performed by the same set of men, who first create the organiza- 
tion and then direct its operations. By their efforts the separate 
factors of production are coordinated into an effective working 
unit. They take the initiative, and as a result of their enterprise, 
the discoveries of science, the machine of the inventor, the money 
of the capitalist, and the labor of others are employed in produc- 
ing commodities or services. They shoulder the responsibility, 
and on their labor the success or failure of the enterprise largely 
depends. They decide what products shall be manufactured, the 
amount of capital required, the location of the plant, its equipment 
with machinery, and the number and character of the labor force. 
They determine the policies of the company, and administer 
them through their appointed executives. They departmentalize 
the organization, select the department heads, and supervise the 
manufacture and sale cf the product. They finally collect the 
money and disburse it as their judgment dictates. They are the 
generals and captains of industry, and their work demands a high 
order of ability. 

The organization and management of any business requires 
not only a knowledge of that particular branch, but a compre- 
hensive grasp of those broad principles which underlie business 
as a whole, and above all, a keen insight into human nature. 
These leaders range from the chief executives of huge corpora- 
tions down to their most humble subordinates, and the heads of 
small individual businesses. Their influence on the industrial 
efficiency of the country is tremendous. The part that intel- 
lectual labor plays in organizing and directing the processes of 
production is of paramount importance. 

DIRECT LABOR— MAN AS A PERFORMER OF THE 
PHYSICAL AND MENTAL WORK OF PRODUCTION 

In the last act of production the curtain rises on the workers^ 
who, under the direction of the management, make and complete 
the product. These constitute the rank and file of the industrial 
army, its salesmen, clerks, mechanics, semi-skilled workers, and 
laborers. 

It is evident that the great bulk of the detailed work of pro- 
duction is performed by this class of workmen. They manipulate 



38 PRACTICAL ECONOMICS 

the tools, tend the machines, fashion the materials, or perform 
the services which result in production. They furnish the tech- 
nical and mechanical skill as well as the manual labor. They 
not only tend the machines, but their labor helps to make those 
machines as well as the capital goods used in production. They 
are indispensable to production; if they did not play their 
part, there would be no wealth produced. 

SUMMARY 

Man as a factor in production supplies the physical and mental 
effort necessary for creating the utilities in economic goods. In 
the transformation of natural resources into finished products 
he performs four main functions. First, he obtains a knowledge 
of the laws and properties of matter by scientific research. Sec- 
ond, he applies that knowledge to the arts of industry by invent- 
ing new machines, processes, or combinations of matter. Third, he 
organizes the factors of production and directs their work. Fourth, 
he performs the work of production under the direction of the 
management. In primitive times the labor of one man performed 
all four of these functions in an act of production. Today they 
are usually undertaken by four different sets of workers, who with 
the aid of capital and organization, cooperate to produce com- 
modities or services. 

TEST QUESTIONS 

1. State the four functions man's labor performs in modern production. 

2. Why should a country for economic reasons recognize and encourage 
the labors of scientists and research workers? 

3. Do you know what policy Germany pursued along this line previous 
to the war? Have you noticed a tendency in this direction in this country 
recently ? 

4. What is the relation of invention to industrial progress? 

5. How do the people of the United States compare with those of other 
nations in reference to inventive genius? 

6. Name six notable inventions produced in the United States within 
the last fifty years. 

7. Why is it some inventors fail to derive any pecuniary reward from 
their inventions? 

8. What further ability is required in order to render an invention of 
service to the nation at large? 



MAN AS A FACTOR IN PRODUCTION 39 

9. What function of labor is performed by the great mass of men? 
10. Show how these four classes of workers cooperate to produce 
wealth. 

REFERENCES 

Carver, T. N., Principles of Political Economy (Chap. IX). 

Fetter, F. A., Economic Principles (Part III). 

GiDE, C, Political Economy (Book II, Chap. II). 

Hopkins, N. M., The Outlook for Research and Invention. 

Marot, H., Creative Impulse in Industry. 

Marshall, A., Principles of Economics (Book IV, Chaps. IV, V, VI). 

Marx, K., Capital (trans, by Amhng, 1887) (Chaps. XIII-XIV). 

Nicholson, J. S., Principles of Pohtical Economy (Book I, Chap. V). 

Phillip, A. The Function of Labor in the Production of Wealth. 

Say, J. B., Pohtical Economy (Book I, Chap. VII). 

Scott, W. D., Increasing Human Efficiency in Business. 

Seager, H. R., Principles of Economics (Chap. IV). 

Seligman, E. R. a.. Principles of Economics (Chap. XIX). 

Slosson, E. E., Creative Chemistry. 

Taussig, F. W., Principles of Economics (Chap. III). 



CHAPTER IV 

THE QUALITIES DETERMINING THE EFFICIENCY 

OF LABOR 

The consideration of natural resources is only preliminary to 
the larger question of national economic efficiency. History has 
repeatedly shown that the wealth of nations is neither limited 
nor determined by the extent of their natural resources. Com- 
pare, for instance, Germany and Russia, Japan and China. The 
source of^ national, as of individual, wealth lies not in material 
possessions, but in mental forces. As we have seen, strip the pro- 
ductive process to the waist, and man remains as its final cause, 
as its primary dynamic agent. Not from its great cities, its fine 
buildings, its huge factories, its wonderful machinery, does the 
wealth of any nation originate, but from the men and women by 
whose united efforts all these came into being. Increase the 
efficiency of the men and women of the nation and you increase 
the production of wealth at its source. An ounce of effort here 
is magnified into a ton of result in the product. There is no 
question so vital to the. general welfare of the nation as the 
economic efficiency of its people. 

THE MEANING OF HUMAN EFFICIENCY 

Efficiency is a ratio between equipment and work done. A 70- 
horsepower machine developing only 35 horsepower is 50 per cent 
efficient; developing 70 horsepower, it is 100 per cent efficient. 
To attempt to get 80 horsepower would endanger the machine. 
Efficiency aims to get 100 per cent from every machine, no more, 
no less. The object of economic efficiency is to develop 100 per 
cent efficiency in the national production machine. This requires 
that each individual worker should develop 100 per cent effi- 
ciency, no more, no less. There is as much difference in the 
capacities of men as of machines. Some men are born with a 

40 



DETERMINING THE EFFICIENCY OF LABOR 41 

35 horsepower, other with a 100 horsepower equipment. Harm is 
done to the man who is forced, or who forces himself by an 
inordinate ambition to work his machinery beyond its capacity; 
but on the other hand, the man who is only getting 40 horsepower 
from a 100 horsepower machine is clearly losing the greater part 
of what he might be making every day of his life. The problem 
before the nation in developing its labor power to maximum 
efficiency involves finding out the present efficiency of the indi- 
vidual worker, his potential capacity, and the principles and 
means through which his latent powers may be developed to 100 
per cent, 

MEASURING HUMAN ABILITY 

This is a problem of no mean order, for although we have bor- 
rowed the terminology of engineering, the task of the human 
engineer is infinitely more complicated. A few years ago it 
would have been impracticable. The recent experimental work 
of applied psychology has brought it, however, well within the 
realm of accomplishment. It is primarily a mental problem. 
The part that human labor plays in production is increasingly 
mental. Man is more and more relegating to machinery physical 
labor, he himself performing only the slighter physical effort 
necessary to control the machine. It is the trained mind that 
counts in modern production. The practical trend of twen- 
tieth century psychology is fast dispelling the mists which have 
for ages shrouded the human mind and its operations. The 
cooperative research work at present being conducted by 
psychologists and business men, who together are searching for 
the mental factors responsible for success and failure in selling, 
clerical work, management and other lines, is resulting in a 
very much clearer analysis of the elements of native ability. 
Rapid strides have been made in applying this knowledge to 
the testing and training of men for various lines of work. Busi- 
ness men everywhere are eager for this information. The 
psychologist is rendering signal service to industry; and he bids 
fair to contribute in the near future data of even greater im- 
portance. Mental measurement is one of the latest develop- 
ments of applied psychology. Psychological tests have been 



42 PRACTICAL ECONOMICS 

prepared for the purpose of determining and measuring the 
mental powers of men. While these tests are yet in an experi- 
mental stage, enough good has resulted to establish their value. 
Several corporations are using them in hiring salesmen and 
bookkeepers, and in adjusting their labor force to the best ad- 
vantage. Similar tests have been used by the United States 
Army to assist in finding out what lines of work different 
men are fitted for. 

GREAT POSSIBILITIES FOR THE DEVELOPMENT OF 
LATENT MENTAL POWERS 

The results of these tests, reinforced by the observations of 
psychologists and efficiency men, indicate that the average man 
is about 40 per cent efficient. The consensus of expert opinion 
certainly points to the fact that the great mass of men are work- 
ing up to only a small part of their capacity. This opens up, 
then, a vast mine of latent power to be developed for productive 
purposes. What it means to the wealth of the nation is incal- 
culable. It means very much more than increasing the present 
annual production 60 per cent. An increase of 60 per cent 
in the mental efficiency of a worker may double or treble his 
product or, if applied to invention and improvement in organi- 
zation, may indirectly magnify the productivity of thousands of 
others. We are dealing now with productive efficiency at the 
source. The next question is, What are the factors on which 
the efficiency of labor depends, under our present system of 
production? 

DISCOVERING THE BASIC QUALITIES DETERMINING 

SUCCESS 

It may seem at first flush that any general discussion of this 
question has little value, owing to the fact that the qualities that 
make for productivity in one line of work may not insure success 
in another; that an accountant requires a different order of 
ability than an advertising man. The difference is more appar- 
ent than real. There are certain fundamental requisites for 
success in all callings. Each line of work may emphasize a par- 



DETERMINING THE EFFICIENCY OF LABOR 43 

ticular quality or set of qualities; one may lay special stress on 
memory, another constructive imagination, so that the exact pro- 
portion of each of these, fitting a man for a particular task may 
vary. Imagination is just as necessary for the head of a big 
business as for an inventor. Ability to analyze is important 
equally to banker and sales manager. But both use these powers 
in a very different way. Success in all lines of business activity 
is based on a few certain well-defined personal factors. Any man 
of average ability, genuinely desirous of becoming proficient by 
developing and training himself in the exercise of these, in what- 
ever line of work he takes up, will achieve success just as surely 
as the sun rises. 

PHYSICAL VIGOR FIRST 

The basic factor is physical health and vigor. Not mainly for 
its direct application to manual labor, as in olden times, but for 
its influence on the mental faculties and its generation of energy, 
the motive power of the mind. The machinery of the mind de- 
pends on power, just as all other machinery. Independent of the 
mental equipment of a man, the amount and quality of the work 
he will do depends on mental energy, which in turn is based on 
physical health and vigor. Not only as a source of mental energy 
is health important, but also for its physiological effects through 
the nervous system on all the mental processes, including the 
emotions, which are of great importance. The way one feels has 
a great deal to do with the way one works ; good health with its 
accompanying exuberance of spirits is worthwhile if only for its 
influence on one's disposition. 

Ill health, itself an expense to the individual and the nation, is, 
of course, directly disastrous to industrial efficiency. The yearly 
loss to the nation in industrial efficiency due to ill health alone 
is estimated at approximately $750,000,000. Yet the more im- 
portant aspect of this factor is not the negative, but the positive, 
the great potential increase in productive power which would 
be realized by an increase in the physical health and vigor of the 
nation, and the resultant quickening of the mental activity on 
which modern productivity mainly depends. The unanimous 
testimony of the great captains of industry such as Gary and 



44 PRACTICAL ECONOMICS 

Schwab, who place health first on their lists of the qualities 
underlying industrial efficiency, backs up with insurmountable 
empirical evidence the causal relation between good health and 
national economic efficiency. 

For the individual worker, in whatever part of the economic 
system he is working, good health, abundant health, should be 
everlastingly sought. The keen strain of modern competition, 
the high speed of industrial processes, the insistent and con- 
tinuous demands of progress for improvement and change, all 
result in driving the worker to intense effort during his working 
hours. To compete successfully in this struggle, the individual 
needs all the vigor and reserve power he can muster. A strong 
body, splendidly healthy, will best equip him for action. Not to 
be merely well, but to be superbly healthy should be the constant 
aim of each individual worker. 

THE DRIVING FORCE OF THE MIND 

The second factor in economic efficiency is mental energy, about 
which we have already spoken, in its relation to health. Men- 
tal energy, however, is not dependent on the physical alone, but 
is a product of both the mind and the body. Desire, purpose and 
will all have a hand in generating and liberating energy. A per- 
fectly healthy man may be disgracefully unenergetic through 
lack of ambition. Once fired with a purpose, he becomes a ver- 
itable dynamo. All creative work, whether in art, literature, 
advertising, or selling, consumes large quantities of this life force. 
Deficient energy is the direct cause of more unfinished tasks than 
perhaps any other one thing. The life of a mentally anemic 
man is strewn with the wrecks of abandoned jobs which have 
miserably perished for lack of the energy to complete 
them. This energy is the driving force of the mind, the source 
of intense and long-sustained effort. Yet the average man uses 
but a fraction of his possible power. He runs on third speed. In 
most men there are reserves of power, never drawn on, never 
dreamed of. The extent of this latent power in a nation opens 
up an interesting field for economic speculation. What this lost 
power amounts to in the myriad-celled reservoir of the national 
mind no adequate conception can be formed. But one thing is 



DETERMINING THE EFFICIENCY OF LABOR 45 

certain — that in its development lies a mine of wealth for the 
individual and the nation alike. 



THE INTELLECTUAL PROCESSES— OBSERVATION- 
MEMORY— IMAGINATION 

Given a sound bodj^, vibrant with health, generating ample 
power, the productive efficiency of the individual next depends 
on the intellectual faculties or processes by means of which the 
mind gathers the materials for its thinking, stores them up, 
organizes them into conclusions, and, in general, performs its 
varied tasks. These are the working factors underlying mental 
ability. The first in order of activity is observation, the search- 
light of the mind. Accurate observation forms the first step in 
all good thinking. Shoddy reasoning and faulty conclusions are 
frequently due to defective observation. It is of direct practical 
value in all lines of work. To the scientist in his collection of 
data, to the salesman in interviewing prospects, to the accountant 
in systematizing and recording; in fact, to all men in whatever 
they are engaged, the power to observe carefully and accurately 
is of primary importance. Psychological tests seem to indicate 
that the average man is not more than 40 per cent efficient in 
observational power. While the exact percentage cannot be de- 
termined, the fact that the great mass of men are bringing to 
bear on their tasks only a small part of their possible powers in 
this respect is undoubtedly true. 

The next factor is memory, whose function it is to retain and 
recall when required the facts observed. Memory is the store- 
keeper of the intellect, who, receiving the raw materials and 
supplies from the purchasing agent, stores them up and gives 
them out on requisition for the use of the other departments 
such as imagination and reason. A poor memory means a con- 
stant loss of valuable stock. Knowledge means power in modern 
business. The man whose acquisitions stick, he who is able to 
recall at will apt and convincing data, is well equipped for effec- 
tive service. Yet the learning of new facts is, with a great many 
men, like filling a bucket with a hole in it. Memory is a basic 
factor in productive efficiency and any improvement in indi- 



46 PRACTICAL ECONOMICS 

vidual memory will result in a marked increase in national 
efficiency. 

If observation and memory supply the mind with the raw ma- 
terials of thought, it is the function of imagination to work them 
up into new products. Imagination takes the ideas stored in the 
mind by memory, and recombines them into new wholes. It is 
the originator of new ideas. Long recognized as responsible for 
the creative work in art and literature, its economic value has 
only recently been emphasized. All constructive work, all in- 
vention, all organization involves the use of the mental process 
we call imagination. A man lacking it may be a good routine 
worker, but he will never become a leader. Business leadership 
requires the power to originate new plans, to devise new proc- 
esses, to foresee and anticipate coming events. Ideas are at a 
premium dn modern business. In advertising, selling and the 
organizing and managerial end of production, men with ideas are 
in urgent demand. Ideas are the very seed of business progress. 
Every great corporation of today once existed as an idea in the 
mind of some man, just as every new step in its progress was 
first projected on the mental drawing board of those engaged in 
its upbuilding. This power of mental projection, called imagina- 
tion, is a fundamental requisite for productive efficiency in the 
modern worker. Though not as much is known about the nature 
of this faculty, as memory, for instance, it is capable of develop- 
ment, and practical methods have been devised by psychologists 
for its cultivation. 

LOGICAL USE OF THE INTELLECTUAL PROCESSES 

Reasoning is a complex process involving the use of the pre- 
ceding factors. By means of it we arrive at our judgments and 
conclusions. Sound judgment is an essential part of executive 
skill. The power to reason out a problem in marketing, manage- 
ment, or financing constitutes the high-water mark of business 
ability. The most vital element in reasoning is the ability to 
analyze out of a thing its essential characteristics. "A genius," 
Bays Carlyle, "is he who sees the essentials of a thing and leaves 
the rest as surplusage." The reasoner searches into events for 
cause, and connecting cause with effect, formulates the principles 



DETERMINING THE EFFICIENCY OF LABOR 47 

which insure success in the work he is doing. Business activities 
are governed by law. There are always reasons for a man's rise 
in business life, just as there are always reasons for his failure. 
The successful conduct of business today demands a knowledge 
of underlying principles. While some of these are already known, 
others remain to be reasoned out. Never in the world's history 
has there been such an imperative demand for trained thinkers 
as today. Drastic internal changes are taking place and prob- 
ably still more radical changes will take place in our economic 
system as a result of post war conditions. Old customs are going 
by the board. New methods will spring up over night. Unprece- 
dented situations and problems will arise, the peaceful solution of 
which will demand a keen analysis of facts and the wise applica- 
tion of fundamental economic principles. 

INTELLECTUAL CONTROL 

The last of the purely intellectual factors is concentration ; the 
essence of which is fixation of attention. Power of concentration 
consists in one's ability to focus all one's faculties on one thing 
to the exclusion of all else. The habit of the immediate direction 
of our powers to one problem, with its complement of immediate 
relaxation when that task is finished, is invaluable in all lines of 
work. More will be accomplished in twenty minutes of con- 
centrated effort than in two hours of ordinary work. Concen- 
tration is a habit that can be acquired through practice. 

PERSONAL CHARACTER TRAITS MAKING FOR ECONOMIC 

EFFICIENCY 

In addition to the foregoing intellectual factors, there are cer- 
tain well-defined character factors, having a definite bearing on 
economic efficiency. A man may be clever intellectually, but if 
deficient in "stick-to-itiveness" he will accomplish little. While 
a worker of mediocre ability, gifted with uncommon persever- 
ance, will outdistance the man of spasmodic brilliancy as the 
tortoise did the hare in the old fable. Keeping everlastingly at it 
brings success in business as certainly as it does in all other 
spheres of activity. Honesty is another essential. The coopera- 
tive character of present-day production necessitates inter- 



48 PRACTICAL ECONOMICS 

dependence. There is no depending on dishonest men. Confi- 
dence and faith are at the basis of modern business and are dis- 
tinct assets to the individual as well as to the nation. The 
cooperative nature of production demands also that each indi- 
vidual possesses the ability to get along with others. Just as on 
a football team, so in the business game, star players are not so 
desirable as those who will work hand in glove with the others. 
It is team work that counts in cooperative production. He who 
cannot obtain the good will of his work mates, whether he be 
employee or manager, is inefficient. For he will get less work out 
of others, while handicapping himself. Inter-departmental co- 
operation, so necessary to the success of the large corporation, 
is impossible if men do not work together in harmony, and many 
an otherwise good department head has lost his seat in the saddle 
for lack of his ability in this direction. Initiative, the power of 
original thought and action, is a quality necessary for those hold- 
ing positions of authority or to those aiming to reach the man- 
agerial end of business. He who does not need to be watched or 
ordered to do every little thing, but who is capable of thinking 
ahead and acting on his own initiative, is an asset in any organi- 
zation. Courage and self-confidence go hand in hand. For all 
our standardization and system, there is an element of risk, 
varying in degree, in different lines of business. The purchasing 
agent, the sales manager, or the organizer stakes his success on 
his judgment. It requires nerve to authorize an advertising 
appropriation running into half a million dollars or to sink a 
million dollars into fixed capital. Successfully to assume respon- 
sibilities necessitates self-confidence. Competition for position is 
keen. The nature of the work required is often difficult and in 
many cases the ability of a man to accomplish that work will 
depend on his belief in himself. Last, but not least, is ambition, 
the most dynamic factor of all — the accelerator of the human ma- 
chine. Without it a man is but a hulk on the business seas. We 
have seen that most men have reservoirs of hidden energy, seldom, 
if ever, utilized. The driving power of ambition uncovers these 
hidden wells, revealing latent powers of which they had never 
dreamed. Men hate to apply the spur, to energize at their maxi- 
mum. In nine cases out ten, love of ease, laziness, indifference. 



DETERMINING THE EFFICIENCY OF LABOR 49 

mediocre effort, are due to lack of ambition. It takes a deep- 
seated purpose to get the best out of a man, and the productive 
efficiency of men is more dependent on ambition than on any 
other one factor. 

THE WELL-INFORMED MIND 

In addition to the factors already discussed is knowledge. 
Knowledge is to personal ability as the shot in the shell is to 
the powder. The effectiveness of the shell depends on a proper 
combination of both, just as the efficiency of a man as a pro- 
ducer depends on his knowledge plus his ability to apply that 
knowledge. Roughly speaking, we can divide knowledge into 
two kinds. First, that general knowledge which goes to make a 
well-informed, broad-minded man. Second, the technical or 
specialized knowledge which equips him for his particular work. 
The extent, character, and availability of knowledge in any 
nation have, therefore, an intimate bearing on its economic 
efficiency. 

SUMMARY 

The factors determining the productivity of the labor power 
of the nation may be grouped under five heads: (1) Health and 
vigor; (2) Mental energy; (3) Intellectual processes; (4) Char- 
acter traits; (5) Knowledge. The problem of labor efficiency is 
largely mental. Psychology has rendered valuable assistance 
to the economist in supplying a clear analysis of the mental 
processes underlying productive ability and in inventing the 
means of approximate measurement of these factors. In the 
light of this knowledge it is manifest that there lies dormant in 
the individuals, constituting the working population of the nation 
a rich mine of productive power capable of development. 



CHAPTER V 

THE DIVISION OF LABOR: ITS ADVANTAGES AND 
DISADVANTAGES 

The productivity of labor depends not only on the inherent 
efficiency of the laborer, but on the degree to which that labor is 
specialized. One of the distinguishing features of our modern 
industrial system is its minute division of labor. Indeed, in no 
other particular is it more strikingly differentiated from previous 
systems of industry than by the extreme degree to which it has 
carried specialization. Under the handicraft system of medieval 
times, the village shoemaker completed a pair of shoes. Today 
in a Brockton shoe factory the making of shoes is often divided 
into one hundred and thirty distinct operations, each performed 
by a separate class of workmen. The radical change which has 
taken place in the making of shoes is typical of the manufacture 
of other products. The old-fashioned watchmaker has been re- 
placed in one of our high-grade watch factories by a thousand 
men, each engaged on one operation of the many necessary to 
complete the watch. The place of the old-time shoemaker, 
watchmaker, or tailor is taken by a host of different workmen, 
each performing but a single operation on the product. 

In the professions specialization is equally marked. The early 
"engineer" has been succeeded by the mechanical, civil, electric, 
hydraulic, gas, chemical, or other engineering specialist, just as 
the old-fashioned medical practitioner has given way to the 
eye, ear, nose, heart, or other medical specialist. Throughout 
our whole economic system specialization is the order of the day. 

IN THE EVOLUTION OF INDUSTRY NO TENDENCY MORE 

MARKED AND PERSISTENT THAN LABOR 

SPECIALIZATION 

The history of industry is largely a record of the division of 
tasks. From what was probably the earliest separation of tasks 

50 



THE DIVISION OF LABOR 51 

that between man and women, down through the medieval trades 
and handicrafts, to the present numerous and varied branches of 
industry, each with its own subdivision of employments, this 
tendency toward division of tasks has been continuously opera- 
tive. The United States Census report on occupations, 1910, in 
speaking of the difficulty of classifying employments, states: 

Formerly under the guild system, to a large degree, each workman 
had a definite occupation or trade as cooper, tailor, shoemaker, etc., 
but with the transition to the factory system, and the great division of 
labor which accompanies it, the tendency has been for each of these 
old handicraft trades, to give place to a number of specific processes 
in the manufacture of the same article. The transition is still in prog- 
ress, so that to-day a workman may make the whole of an article, or 
perform several of the processes in its manufacture or perform only one 
of them. 

The latest manifestation of this tendency is seen in "scientific 
management," which carries out the principle of division of 
labor in a systematic manner. The task of the workman after 
accurate observation by an expert is split up into simple move- 
ments; unnecessary motions are eliminated and the remainder 
arranged into convenient groups, each group constituting a 
separate task. The workmen are then taught to perform this 
task in the manner which the experts have determined by scien- 
tific study to be the most efficient. Scientific management intro- 
duces a new, or at least a greater, degree of specialization into 
the work of the management itself; a specialization based on 
functions, on account of which Frederick W. Taylor termed his 
new system of management 'Afunctional management," which 
he defines as, 

so dividing the work of management that each man from the assistant 
superintendent down shall have as few functions to perform as possible. 
If practicable the work of each man in the management should be 
confined to the performance of a single leading function. 

In carrying out this principle he first divides the work of shop 
management into two main divisions — planning and executing. 
The work of planning is concentrated in a planning department 
consisting of four men, the "order of work clerk," "instruction 



52 PRACTICAL ECONOMICS 

card man," "time and cost clerk," and "disciplinarian." The 
work of execution is performed by four others: The "gang boss," 
"speed boss," "inspector," and "repair boss," who see that the 
work is carried out by the workmen exactly as it has been 
planned. The gang boss shows the men how to set up the work 
in their machines, and sees that there is a new job ready for a 
man as he finishes his old one. The speed boss sees that the 
proper cutting tools, with the speeds, feeds, and depths of the 
cut are used which the instruction card directs. The inspector is 
responsible for the quality of the work. The repair boss sees that 
the machines are kept oiled, cleaned and in first-rate working 
condition. Each of these men is ready not only to advise but to 
pitch in and show how the work should be done. Under this 
system the old-fashioned foreman has been replaced by eight 
specialists, called functional foremen, each of whom performs 
but one of the eight duties previously the work of one man. 

DIVISION OF LABOR BASED ON A UNIVERSAL LAW OF 
ORGANIC DEVELOPMENT 

Division of labor may be defined as the dividing up of what 
was previously one economic task into several parts, each con- 
stituting a new task to be performed by a separate individual. 
This principle we have seen to be in operation ever since "Adam 
delved and Eve span." It is by no means limited to economic 
activities, but is a universal principle, operating in every sphere 
of life. In evolution it is termed "differentiation," or "division 
of functons," and is a process observed in the development of all 
forms of organic life. In the progress of organisms from simple 
to complex forms, from the lower to the higher; with the de- 
velopment of special organs, comes a corresponding increase of 
functions or division of tasks. As a new organ develops it takes 
over a special task, either to supply a new need of the organism 
or one previously undertaken by other organs. In the simplest 
form of organism consisting of a single cell the one cell performs 
all of the simple functions of life — seeing, eating, digesting, loco- 
motion, and reproduction. Higher up in the scale of life we find 
animals endowed with separate organs for the performance of 
these special functions, an eye to see with, a stomach for digest- 



THE DIVISION OF LABOR 53 

ing food, feet for locomotion. The higher in the scale of life the 
organism, the greater the degree of specialization. 

The same law is observed in the progress of economic societies 
and in the organizations within them; there is a development 
from simple to complex forms accompanied with an increasing 
division of labor. A high degree of division of labor would be 
impossible in a primitive state of industrial society. The extent 
to which this principle has been carried today in the United 
States has been made possible by the development of its systems 
of transportation and internal communication, its complex sys- 
tem of money and credits, and its industrial organizations. This 
law of division which lies in the nature of all organic develop- 
ment and which man has followed more or less blindly for ages 
in the performance of his work has now been recognized by 
modern scientific management, which adopts as a fundamental 
princple that all tasks be so divided that each worker is confined 
to that simple operation which he can perform the most efficiently. 

SIMPLE AND COMPLEX DIVISION OF LABOR 

The fact that division of labor has proceeded from simple to 
complex forms has led some economists to classify division of 
labor under the two heads, simple and complex. The classifica- 
tion is, of course, an arbitrary one. The degree of division has 
been continuously increased and is being today, so that the ex- 
tent prevailing at any one time would appear complex compared 
to that of the previfous period. However, this two-fold classi- 
fication roughly corresponds to two general stages in the history 
of division of labor. By simple division is meant the splitting 
up of the work of production into crafts or trades, a form of 
division which dates back to antiquity, but which reached its 
climax in the guild system of medieval times, the golden age of 
the craftsman. It still persists; the doctor, dentist, carpenter, 
and custom tailor are modern examples. By complex division is 
meant the separation of the trade or craft into several processes, 
which in turn are subdivided into minute operations. Thus the 
making of cloth is divided into spinning, weaving, dyeing, fulling, 
and finishing, and these again still further subdivided. A rather 
freely quoted but exceedingly apt illustration of the effect of 



54 PRACTICAL ECONOMICS 

complex division of labor on the craft of the old-fashioned 
butcher is given by Professor Commons in his description of 
labor conditions in the meat-packing industry: 

Notwithstanding the high skill required, the proportion of skilled 
workmen in the butchers' gang is very small, owing to a minute division 
of labor. It would be difficult to find another industry where division 
of labor has been so ingeniously and microscopically worked out. The 
animal has been surveyed and laid off like a map; and the men have 
been classified in over thirty specialties and twenty rates of pay, from 
16 to 50 cents an hour. The 50-cent man is restricted to using the 
knife on the most delicate parts of the hide (floorman) or to using the 
axe in splitting the backbone (splitter); and, wherever a less skilled 
man can be slipped in at 183^ cents, 20 cents, 21 cents, 22^/^ cents, 
24 cents, 25 cents, and so on, a place is made for him, and an occupation 
mapped out. In working on the hide alone there are nine positions, 
at eight different rates of pay. A 20-cent man pulls off the tail, a 
223/^-cent man pounds off another part where the hide separates read- 
ily, and the knife of the 40-cent man cuts a different texture and has 
a different "feel" from that of the 50-cent man. Skill has become 
specialized to fit the anatomy. 

GENERAL INCREASE IN PRODUCTIVITY DUE TO 
DIVISION OF LABOR 

Though the individual appreciates the value of specialization 
in reference to his own work, he fails as a rule to realize the tre- 
mendous increased productivity in the nation as a whole that 
results from the ever-widening application of this great principle 
to the arts of industry. It is hard for a twentieth century man 
even to conceive an industrial society devoid of division of labor. 
To do so would l)e to go back to primitive times when each indi- 
vidual shifted for himself. So far has this principle raised us 
above our ancestors that the mere idea of a civilized man making 
his own shoes, clothes, furniture, and food from start to finish is 
as ludicrous as it would be impracticable. So accustomed have 
we become to the advantages of our present system that we sel- 
dom stop to think of the variety and number of specialized 
workers who contribute to the making of even the most common 
articles of daily use. So simple an article as the collar we wear 
involves the storekeeper and his staff, from whom we purchase it, 



THE DIVISION OF LABOR 55 

the manufacturer with his salesmen, the members of his organi- 
zation, his skilled and semi-skilled labor force (a collar passes 
through a hundred and fifty different hands in its making in the 
factory), the textile workers who made the cloth, the planters 
who raised the cotton, the makers of the tools, machines, and 
buildings for all these, the railroad companies and employees 
who transported all these commodities, and so on back through 
an endless maze, each worker as superior to us in his particular 
line as we are to him in ours. To the cumulative increase in pro- 
duction arising from this division of labor is largely due the 
luxury and wealth of civilized life. 

DIVISION OF LABOR INCREASES PRODUCTION IN THE 
FOLLOWING WAYS 

First, by adding to the skill and dexterity of the workman. 
It is obvious that a man will attain more skill by confining him- 
self to one trade than by becoming a "Jack of all trades." Prac- 
tice makes perfect, and the law of habit enables the task to be 
carried out almost automatically, with a minimum of fatigue. 
Speed, ease, and accuracy result. 

Second, by shortening the period of preliminary training neces- 
sary for the learning of a trade. The more minute the division 
of labor, the shorter the task, and the easier it is mastered. In 
the skilled trades the seven years apprenticeship has shrunk to 
three and with the rapid increase of semi-skilled jobs, and the 
minute division of labor due to efficiency engineers, the requisite 
training for many jobs can be acquired in from two days to three 
months. This is illustrated by the situation in the foundry of 
the Ford Automobile Company. 

The big foundry is now working about 1,450 men all-told. Of the 
moulders about 55 men in the jobbing department are all-round mold- 
ers. Of the others perhaps 5 per cent are skilled molders and core- 
setters, the remaining 95 per cent are simply specialized laborers. Many 
of them never having seen the inside of a foundry, who being given one 
piece only to put up learned the "trade" in two days (if a man cannot 
learn to put up a small plain job in two days the Ford foundry bosses 
pass him up as hopeless) and began to turn out a full day's work of 
good castings on the third day of employment. "Ford Methods and 
Ford Shops," by Horace L. Arnold, Eng. Mag., Vol. 48: 524. 



56 PRACTICAL ECONOMICS 

Third, by permitting the most economical utilization of labor. 
In the meat packing industry just referred to, of a gang of 230 
men killing 105 cattle an hour, 11 were paid 50 cents an hour, 3 
received 45 cents, while 86 were paid 20 cents and over, and 144 
got under 20 cents. Instead of the whole job being done by all- 
around butchers it is so divided that the small part of the work 
demanding a high degree of skill is delegated to 11 picked men; 
that requiring only mediocre skill is given to the 86 men of 
medium grade, while the greater bulk of the work which requires 
no special ability is dispatched by the lowest grade of labor. 
The great shortage of skilled labor in British industries during 
the war has given rise to the practice described as "the dilution 
of skilled labor." The work previously done by the skilled 
mechanic or other tradesman has been so subdivided that the 
operations requiring a lesser degree of skill are performed by 
women, after a brief preliminary training, leaving only the 
finishing touches or those operations demanding the highest 
degree of skill to the mechanic. 

Under scientific management the tasks are divided according 
to the grades of ability required to perform them, and the men 
are carefully selected with a view to their fitness for each task. 
The planning and routing of work is taken out of the hands of 
the workmen and given to men selected by the management for 
their superior education and ability who perform this work very 
much more efficiently than the workmen. The skilled mechanic 
is relieved of the unskilled work connected with his task and, 
therefore, turns out a larger product, while the specialized 
laborers dispatch their simplified tasks with the accuracy and 
speed borne of constant repetition. Thus tasks are scientifically 
divided according to brain, brawn or skill, and the ability of 
each worker is applied in the most productive manner. 

Fourth, by confining himself to one task the specialist saves 
the time which would otherwise be lost in passing from one job 
to another. A workman doing two or three kinds of work often 
wastes time in either changing tools or in shifting his position 
from one place to another. 

Fifth, by simplifying the task division of labor facilitates the 
substitution of machinery for hand work. Once a task is reduced 



THE DIVISION OF LABOR 57 

to the mechanical repetition of a few simple operations the next 
step is the invention of a machine, which will perform the task 
with greater speed and accuracy than the human hand. The 
simple division of labor existing in the beginning of the 18th 
century in England paved the way for the mechanical inventions 
that ushered in the industrial revolution. The textile industry 
which early showed a division into processes, as spinning, weav- 
ing, fulling and dyeing, took the lead in the adoption of 
machinery. Spinning which involved the mechanical twisting of 
the cotton fibre, was first taken over by a machine. Hargreaves 
in 1764 invented the spinning jenny, which was followed in 1769 
by the water frame of Richard Arkwright. In 1779 Crompton 
patented his spinning mule, which combined the good points of 
the previous two inventions, and produced a finer and stronger 
thread at a faster rate. Attention was next turned to the more 
complicated process of weaving, with the result that in 1782 
Edmund Cartwright invented the power loom. Watts' improve- 
ment of the steam engine, made possible the use of steam as a 
motive power, and by the beginning of the nineteenth century 
machinery had supplanted handwork in the textile industry. 

No sooner had division of labor admitted machinery into 
the industrial system than machinery began to repay the good 
turn by advancing specialization. These two aid and abet each 
other; division leads to the use of machinery and machinery 
induces further division of labor. The specialized machine calls 
for a specialized worker. A host of semi-skilled craftsmen and 
specialized laborers has sprung up in our factories and offices, 
whose function in life it is to operate the machine. The tendency 
is, however, for the machine to become more and more self- 
sufficient, to require less and less skilled supervision by the 
operator, who in many cases is only required to start and stop it. 
The question arises as to whether the development of automatic 
machinery will not eventually reduce machine operation to the 
level of common labor, demanding only specialized skill for 
setting up the machines. A second way in which machinery 
has increased division of labor is through the creation of those 
industries engaged in the making of machinery, and their 
dependent trades and professions, such as the various branches 



58 PRACTICAL ECONOMICS 

of mining and engineering. These give rise to a widespread 
division of labor, resulting in an endless variety of specialized 
occupations. 

Under scientific management the substitution of machinery 
for man power has been carried to an extent hitherto impossible. 
Motion study work, one of the foundation stones of scientific 
management, has as its object the reduction of jobs to a few 
simple and mechanical operations. The next step, the invention 
of a machine to accomplish the task, is thus greatly facilitated. 
In those shops where scientific management has been adopted or 
where motion study work only has been carried out, the substitu- 
tion of machinery for human labor has been remarkably accel- 
erated. As efficiency engineers bend their energies toward 
reducing human tasks to fewer and simpler operations, the easier 
it becomes to replace the man by a machine which performs 
the work with greater speed, accuracy and ease than any man 
could possibly do it. Scientific management thus greatly pro- 
motes the use of machinery through its minute subdivision of 
labor, and is destined, as it becomes more universally adopted, 
to extend the application of machinery to human tasks to a 
degree today scarcely realized. 

THERE ARE THREE DISADVANTAGES CLAIMED AGAINST 
DIVISION OF LABOR 

First, that the narrow range of activities of highly specialized 
work leave no play for the use of the higher faculties, while the 
monotony borne of constant repetition exerts a deadening effect 
on the worker. It is a question whether division of labor is to 
blame for the monotony and lack of the educational element in 
many kinds of specialized work. A large class of skilled and 
semi-skilled technical work and ordinary labor, which has been 
specialized, never was of a particulary elevating or broadening 
character. This much may be said for division of labor, that it 
tends to counteract the narrowing effect of work by allowing 
many hard and monotonous hand tasks to be given over to ma- 
chinery, and also tends, as a result of increased productivity, to 
decrease the hours of labor. It is further claimed that the spe- 
cialized worker is forced to take a greater risk, in that he must 



THE DIVISION OF LABOR 59 

depend on one small job, to earn his living. This danger is 
lessened by the fact that specialization in shortening the prepara- 
tory period of training enables the worker to master a new trade 
with greater ease, or to learn two trades, holding one as a re- 
serve in case the other fails. In many shops where scientific 
management has been introduced, in the Franklin Car shops, for 
instance, the men are encouraged by a higher rate of pay to learn 
two jobs. It has been further charged against specialization, 
that owing to the narrowness of their training, the workers are 
unable to adapt themselves to new conditions and methods, and 
thus industrial progress is hindered. This is true provided work- 
men depended on their jobs for their education and training. 
It would be manifestly unjust, as well as disastrous, if the worker 
did not receive in shorter hours and increased pay, part of the 
benefits derived from the superiority of his specialized labor. 
There is a tendency to reduce working hours, also to increase 
b.y law the period of education the boy must have before he is 
^allowed to work. By extending the schooling of the youth 
previous to his becoming a worker, and allowing him more leisure 
to continue his education after he becomes a worker, the harmful 
effects of specialization will be negatived. 

DIVISION OF LABOR DEPENDENT ON THE EXTENSION 
OF THE MARKET 

It is evident that there could be no division of labor without 
exchange. One man could not spend his entire time making one 
product, unless there were others with whom he could exchange 
that product, for the things he needed. And in order for him to 
exchange his whole output there must needs be a sufficient num- 
ber of accessible consumers. In other words, division of labor 
is limited by the extent of the market for the product. The 
small town of the middle ages afforded a sufficiently large market 
for the shoemaker, but it could not have absorbed the output of 
a modern shoe factory turning out a thousand pairs of shoes a 
day. Through the invention of the locomotive by Stephenson 
and of the steamboat by Fulton in the beginning of the nine- 
teenth century, with the remarkable development of transporta- 
tion which has resulted, the village market has been extended to 



60 PRACTICAL ECONOMICS 

include the nation and for many products the world at large. 
This extension of the market by transportation has made pos- 
sible the production of commodities on a scale large enough to 
enable manufacturers to avail themselves of the advantages due 
to specialization. 

LOCALIZATION OF INDUSTRY 

There is a geographical division of labor resulting in the 
concentration of certain industries in particular localities. 
Owing to the development of transportation, which has allowed 
goods to be profitably marketed at an ever increasing distance 
from the plant where they were manufactured, the localization 
of industries, during the last hundred years, has proceeded at a 
rapid rate. Thus Pittsburgh specializes in the production of 
steel, Akron in rubber, Troy in collars and shirts, Detroit in 
automobiles. Districts and nations follow the same principle on 
a wider scale; California supplies citrus fruits, the middle west 
grain, the south cotton. East Pennsylvania anthracite coal, while 
New England makes textiles, shoes and other manufactured 
goods. Great Britain devotes itself to manufacturing and 
exchanging its products for raw materials and goods; mutton 
and wool from Australia and New Zealand, wheat from Canada 
and United States, cotton from India and the South. Just 
as individuals confine themselves to one occupation, so do local- 
ities specialize in the production of certain commodities. 

The following are the chief factors determining the localiza- 
tion of industries. Cheap and plentiful power exerts a magnetic 
influence in attracting industries to particular districts. Pitts- 
burgh owes its superiority as a steel centre to its proximitj'^ to the 
finest beds of coking coal in the world, as well as to its supply 
of that purest of fuel — natural gas. A second factor is the avail- 
ability of raw materials. This operates most extensively in the 
extractive industries. Memphis owes its importance as a lumber 
centre to its nearness to the forests of the south. The city of 
Lancaster, situated in the midst of the rich tobacco growing 
county of Lancaster, Pennsylvania, spends most of its time in 
making tobacco and cigars. Proximity to markets is another 
factor not as important as it was before the development of 



THE DIVISION OF LABOR 61 

transportation but still important. New England is a manufac- 
turing centre today primarily because those states were popu- 
lated when industries were being established. Since 1850 the 
centre of manufacturing has followed the centre of population 
westward. The importance of proximity to markets and raw ma- 
terials depends on the cost of transportation. Climate of course 
largely determines agricultural specialization and also affects 
manufactures. Cotton spinning requires a moist climate, to- 
bacco a dry atmosphere. A plentiful labor supply is a vital 
factor. Manufacturing industries tend to locate in those dis- 
tricts where there is a good supply of labor. Often an industry 
owes its start in a locality to accident. Lynn, Massachusetts, 
owes its prominence in the shoe industry to the fact that in 1850 
John Adams Dagyr, a skilled Welsh shoemaker, settled there 
and became famous all over the country as a maker of fine shoes. 
Had he taken up his residence in North Adams, Massachusetts, 
that city might have been a centre for the shoe industry. Once 
an industry secures a flying start in a community certain in- 
herent advantages arise which tend to perpetuate it. It acquires 
a specialized labor force, a fact alone which offers a powerful 
incentive to new plants seeking a location. 

The big reason why the shirt and collar business grew to such pro- 
portions in Troy was its labor advantages. For a great many years 
after the industry was established in Troy only hand labor and prac- 
tically no machinery was used in the manufacture of collars or shirts. 
Considerable skill was required to do the work at all and much more 
to do it efficiently and expeditiously. 

The people who took up this employment were the natives of the 
district, an exceptional class of people, usually having had good home 
surroundings and educational advantages. No foreign labor was then 
and little is even now found in the factories. 

Such people naturally furnished very high-class service to their 
employers. Their children grew into the work, and succeeding genera- 
tions in turn fell heir to these occupations. In this manner and by 
natural growth there grew up and was established a highly skilled class 
of employees in the Troy collar factories. 

As the business expanded, it was thought, for very good reasons, that 
the establishment of factories in other parts of the State would be 
advisable. But practically all attempts to start factories elsewhere 



62 PRACTICAL ECONOMICS 

were complete failures on account of the lack of trained labor. It was 
found that this labor could not be trained in any reasonable period 
of time. 

In recent years the situation has changed somewhat on account of 
the fact that a great deal of machinery has been introduced. Troy still 
has a great advantage as a collar manufacturing center, however, for 
training in the use of the machinery in this industry is local to this 
section. 

Other advantages arise from the conveniences which accrue 
to dependent and interdependent industries being situated to- 
gether. Those allied trades manufacturing the machinery, sup- 
plies and accessories, find a ready market for their products 
while those using the by-products of the bigger industries are 
handy to their raw material. Thus specialization facilitates 
cooperation, the advantage of which induce still further speciali- 
zation. 

By the operation of this principle each locality tends to pro- 
duce those commodities to which it is best adapted by situation, 
skill, climate or resources. If this ideal could be universally and 
completely realized, and each district and each nation produce 
only those commodities which it could produce more economi- 
cally than others, and exchange those commodities for the prod- 
ucts more economically produced by other localities, all goods 
everywhere would be produced at lowest cost. Besides trans- 
portation costs, which limit this process, there are political 
reasons which make this course unwise under present conditions. 
These will be discussed later. 

TEST QUESTIONS 

1. How is the principle of division of labor carried out in F. W. Taylor's 
system of Scientific Management? 

2. Give a definition of "division of .labor." 

3. What part does this principle play in the evolution of all living 
organisms and economic organizations? 

4. Distinguish between simple and complex division of labor. 

5. Show how division of labor is carried out in the making of any 
ordinary article such as a collar. 

6. Explain six of the chief advantages of this principle. 

7. What is the relation between machinery and division of labor? 

8. Name three disadvantages of division of labor. 



THE DIVISION OF LABOR 63 

9. What connection is there between division of labor, transportation, 
the extension of the market and large scale production? 

10. Name the factors governing the location of industries. 

11. Why is Pittsburgh a steel center? Troy the center of the collar 
industry? Lynn a shoe manufacturing city? 

12. What advantage arises from geographical division of labor? 

REFERENCES 

Babbage, Economy of Machinery and Manufacture (Chaps. XIX-XXIII). 

Carver, T. N., Principles of Political Economy (Chap. X). 

Clay, H., Economics for the General Reader (Chap. II). 

Marshall, A., Principles of Economics (Book 14, Chap. IX). 

Nicholson, J. S., Principles of Political Economy (Book 1, Chap. VII). 

Palgrave, Dictionary of Political Economy (Vol. 1 :608) . 

Say, J. B., Pohtical Economy (Book 1, Chap. VIII). 

ScHMOLLER, Jahrbuch fiir Gesetzgebung. 

Seligman, E. R. a.. Principles of Economics (Chap. XIX). 

Smith, A., Wealth of Nations (Book — , Chap. I). 

Taussig, F. W., Principles of Economics (Chap. III). 

Taylor, F. W., Shop Management. 



CHAPTER VI 

CAPITAL AS A FACTOR IN PRODUCTION 

CAPITAL A DERIVED FACTOR 

We have thus far discussed only the two primary factors of 
production, nature and man, the former contributing the raw 
materials and forces, out of which and by whose aid all wealth is 
produced; the latter, the manual and mental effort required in 
the process. To the action of these two elemental agents the 
production of all wealth can finally be traced. There figures, 
however, in the roundabout system of modern production, a 
third factor termed capital, a product of nature and labor, but 
which assumes in the intervening period occupied by the chang- 
ing of the raw material into the finished product the character 
of a separate factor. Though all capital can be analysed into 
its two constituent elements, nature and labor, it is convenient 
for practical purposes to distinguish it as a separate agent, just 
as in practical affairs we deal with water in preference to its two 
constituent elements, hydrogen and oxygen. 

The derived nature of capital might be illustrated in the sim- 
ple case of a woodman felling a tree. The woodman represents 
labor, the tree nature, the axe capital. The woodman as a man, 
the tree as a product of nature are elemental factors in the 
process, each is finally responsible for the part it plays in the 
production of timber. But what about the axe? Does responsi- 
bility terminate in that also as an elemental factor? Evidently 
not, for whether the axe serves its purpose well or ill depends 
on the material of which it is composed and the skill exercised 
in its construction. In other words, nature and labor are re- 
sponsible for the productivity of the axe. From the mining of 
the ore, in the various stages through which it has passed in 
its transformation into the keen edged head of an axe, labor 

64 



CAPITAL AS A FACTOR IN PRODUCTION 65 

and natural forces acting together, have fashioned it, with the 
aid of tools previously made in the same manner. It cannot be 
counted a primary factor in production any more than a rifle 
in the hands of a man who had shot another could be counted, 
as a primary factor in the killing, though both axe and rifle 
would be important secondary factors. It is in this sense that 
capital figures as a factor in production. 

IMPORTANCE OF CLEAR CONCEPTION OF CAPITAL 

The increasing dependence of industry on capital and capi- 
talistic methods of production, coupled with the tendency for 
its control and ownership to concentrate into the hands of large 
corporations, governed by a few individuals, has given rise 
to problems which powerfully affect the welfare of the whole 
nation. For the peaceful and just solution of these, a clear 
conception of the nature of capital, the services it performs, 
and its relation to labor, are absolutely necessary. Conflicting 
interest, as well as the complex nature and operation of capital 
itself, tend to confuse ideas, and have given rise to different 
opinions as to what is and what is not capital. 

DIFFERENT DEFINITIONS OF CAPITAL 

An introductory text on economics should not confuse the 
mind by a consideration of dissimilar definitions; but on the 
other hand the student should not be kept in ignorance of the 
fact that in the field of economic theory men cross swords to 
decide the truth. Capital, as defined by Adam Smith is, ''that 
part of a man's stock which he expects to yield him a revenue." 
He would exclude a dwelling house occupied by the owner. 
Hermann, who makes the distinction between capital and non- 
capital, that between durable and perishable goods, would in- 
clude a house as a capital good, but would exclude, on account 
of its perishability, fruit in a fruiterer's store, which Adam 
Smith again would call capital. Some economists include all 
wealth as capital; others, as Clay, confine capital to that part 
of wealth used for production; while still others, as Kleine- 
wachter, would further limit it to the tools of production alone. 
Again some authors strictly limit capital to material goods, 



66 PRACTICAL ECONOMICS 

others, as McLeod, extend it to include immaterial goods which 
produce profit, including labor, credit, art, education and even 
an author's mind. Karl Marx confines capital to those product- 
ive instruments which are to be found in the hands of persons 
other than the laborers, and are used to exploit the laborers. 
With him capital is a "means of exploitation." Jevons, on the 
contrary, conceives capital as ''the aggregate of those com- 
modities which are required for sustaining laborers of any kind 
engaged in work." Bohm-Bawerk stoutly maintains, "that it 
is not the means of subsistence, and in particular it is not the 
means of subsistence alone, that constitutes capital. Capital 
only comes into existence when man enters upon that profitable 
roundabout journey that the means of subsistence have made 
possible; when he builds machines, tools, factories, raises raw 
materials, and so on." 

All of which recalls of an incident in the life of the late 
William James. While on a hunting trip he returned to camp 
to find his companions engaged in a ferocious dispute; feelings 
ran high and friendship was strained to the breaking point. 
James was asked to decide the question which was this: sup- 
pose a squirrel to be on the trunk of a tree, and a man 
were to encircle that tree; does the man go around the squirrel 
or not? (He goes around the tree sure enough and the squirrel 
is on the tree, but does he go around the squirrel?) One side 
maintained he did not, for as he circled the tree, so did the 
squirrel, always keeping the tree between himself and the man. 
The other side were just as emphatic in stating that he did, 
because if he went around the tree and the squirrel was on 
the tree, he must go around the squirrel. James decided the 
issue by affirming that which party was right or wrong de- 
pended entirely on what was practically meant by "going around 
the squirrel." 

If you mean, said James, passing from the north of him to the east, 
then to the south, then to the west and then to the north of him again, 
obviously the man does go around him. But if on the contrary you 
mean being first in front of him, then on the right of him, then on his 
left, and finally in front again, it is quite as obvious that the man 



CAPITAL AS A FACTOR IN PRODUCTION 67 

fails to go around him, for by the compensating movements the squirrel 
makes, he keeps his belly turned toward the man all the time. Make 
the distinction and there is no occasion for any dispute. You are 
both right and both wrong, according as you conceive the verb, "to 
go around" in one practical fashion or another. 

WHAT IS PRACTICALLY MEANT BY CAPITAL 

So with regard to the conception of capital. The difference 
of definition is due primarily to the fact that economists differ 
in what they "practically mean" by capital. As Bohm-Bawerk 
puts it: 

The material difference in the definitions is not so much that the 
one thing to be defined appears to each in a different light, as that each 
one is defining an entirely different thing. 

After all it does not so much matter what capital means as 
what we mean by capital. And by capital as a factor in pro- 
duction we mean all economic goods used as aids to further pro- 
duction; all wealth used for this purpose is capital. 

CATEGORY OF CAPITAL GOODS 

This definition automatically divides wealth into two parts: 
first, consumption goods, comprising all commodities possessed 
by consumers, for the satisfaction of wants; second, capital goods 
consisting of all commodities in the hands of producers, used 
for productive purposes, such as: 

1. Permanent improvements in land, as drainage systems, 

harbors, dams and fences 

2. Buildings used in production, as factories, barns, power- 
houses, also rented dwellings 

3. Tools and machinery 

4. Rolling stock of railroads, trucks and wagons 

5. Horses and other beasts of burden 

6. The raw and auxiliary materials of production 

7. Stocks of goods on dealers' shelves 

8. Money. 

It has been said that the difference between capital and con- 



68 PRACTICAL ECONOMICS 

sumption goods is but a difference of degree, in the sense that 
both are means to the satisfaction of wants, both yield utilities 
— the difference being that the former usually yield their utili- 
ties indirectly and slowly, but the latter directly and more 
immediately. This difference, however, is fundamental and fully 
justifies the distinction. Capital goods are in the hands of pro- 
ducers for the purpose of further production; consumption goods 
are in the possession of consumers for the purpose of consump- 
tion. The former are circulating in the course of exchange; 
the latter are withdrawn from the market in the hands of private 
individuals: the former add to the productivity of labor, the 
latter do not. The distinction then is not only fundamental 
but practical for it marks off for separate study a complex 
but concrete group of intermediate products whose common func- 
tion is to act as an aid to labor in production, and aid without 
which industrial society could not for one moment produce 
those multitudinous things that go to make modern life worth 
while. 

FIXED AND CIRCULATING CAPITAL 

Capital is sometimes spoken of as either fixed or circulating. 
These are terms of common usage and like most popular distinc- 
tions they are based on a practical difference in the nature of the 
two kinds of capital goods they distinguish. In modern industry 
capital goes through a series of cycles. It usually starts in 
the hands of the entrepreneur in the form of money or credit, 
with which he enters the market and purchases plant, machin- 
ery, raw materials, etc. These are transformed in the processes 
of production into the finished product which is sold on the 
market- for money. This cycle from money into money consists 
of three stages. First: that in which the money capital is ex- 
changed into elementary capital goods. Second: wherein these 
goods are transformed into the finished product. Third:- whereby 
the produced commodities are exchanged into more money. With 
this money the entrepreneur again buys more elementary capital 
goods and the cycle is repeated. This periodical rotation of 
capital is called its turnover. From the point of view of the 
business man, the turnover is the length of time his money 



CAPITAL AS A FACTOR IN PRODUCTION 69 

capital takes to reproduce itself in the price of the product, 
plus of course an added value in the shape of a profit. While 
the length of this time varies in different branches of industry, 
the year is usually taken as the unit time of the rotation or 
turnover of capital. 

Now it is the relation which capital goods bear to this unit 
period of production that has led to the distinction between fixed 
and circulating capital. Most of the raw and auxiliary mate- 
rials used in production pass into the product of the current 
period, and their total value is reproduced in the price of that 
product. These forms of capital are termed circulating capital 
goods. It might be well to introduce here auxiliary capital 
goods. Some of the materials of production enter directly into 
the product with of course a change of form, as iron ore into 
steel, and sand into glass. Others, however, such as the gas used 
for fuel in a blast furnace or oil used for machinery, do not 
pass bodily into the product, though they do add value to 
the product; these are termed auxiliary capital goods. Most 
auxiliary capital is circulating capital and is merged in the 
current product with the raw materials. An exception to this 
would be fertilizer applied to land, the benefits from which 
might be spread over two or three years' crops. In this case 
part of the value of the fertilizer would be transferred to the 
current crop, part would remain in the ground. 

Distinct from the above means of production which are con- 
sumed within the current period are the bulk of the instruments 
of production, plant, machinery, etc., which last for years and 
yield a part of their capital value to the product of the cur- 
rent period. These do not circulate bodily into the product 
in the same manner as the raw materials but retain their origi- 
nal form, separate from the product they helped to create. Their 
value, however, they do yield to the product, but by degrees. 
If the life of a machine is ten years, it is apparent that its total 
value is distributed to the product which it has helped to create 
in that ten years. At the end of the first year one-tenth of the 
capital value of the machine will usually have passed into the 
product of that year, but nine-tenths remains "fixed" in the 
machine, the predominant capital characteristic of which is 



70 PRACTICAL ECONOMICS 

fixity, hence its name, fixed capital. It does circulate but with 
the slowness of the tortoise, not the speed of the hare. As Karl 
Marx aptly puts it: "In the performance of its function that 
part of the value of an instrument of labor, which exists in its 
natural form constantly decreases, while that which is trans- 
formed into money constantly increases, until at last the in- 
strument is exhausted and its entire value detached from its 
body, has assumed the form of money." In business this trans- 
formation is brought about through a depreciation account. 
Supposing the life of a $1,000 machine to be ten years, with 
a scrap value of $100, $90 would be deducted from the money 
price received for each year's product and placed in the deprecia- 
tion account, this fund with the $100 received for the scrap 
in ten years would contain the amount of money originally 
invested in the machine. 

THE PRODUCTION OF CAPITAL 

It is conceivable that in the life of primitive man there was 
a stage when all his labor was demanded to provide food, cloth- 
ing and shelter for immediate needs. As long as all his work- 
ing hours had to be spent hunting food to keep body and soul 
together, he could accumulate no capital. In order to provide 
tools to satisfy future wants more effectively he must first spare 
some part of his labor from the satisfaction of present needs. 
He might set aside one hour each day for the making of tools 
or weapons, in which case these capital goods would arise di- 
rectly from the labor power saved from the satisfaction of pres- 
ent needs. Or our primitive man might lay by a portion of food 
gathered each day until he had a sufficient store to last him 
while he devoted his whole time for two or three days to the 
construction of his implements. In this case the food saved 
would be used to allow of future labor power being applied to 
the making of the tools. Here the first form of capital would 
be in the shape of a store of food, withdrawn from consumption, 
to be used for the purpose of further production, the implements 
produced would be the second form of capital, which the first 
form aided in making by setting free the labor power necessary 
for their production. All capital comes into existence, in the first 



CAPITAL AS A FACTOR IN PRODUCTION 71 

place, through this labor power saved from the application to 
present needs and applied to the purpose of further production. 
This surplus labor may be turned directly into some instrument 
of production or into a store of goods, to be used for the libera- 
tion of future labor power, for production purposes. In a 
modern industrial society this store is not saved in the form of 
actual commodities but in the shape of money which is used for 
the same purpose as the store of primitive man, for the libera- 
tion of labor power for production purposes. 

Take the case of a farmer. By saving part of his wheat 
crop he provides himself with capital in the form of seed for 
the following year. But in order to add to his equipment of 
other kinds of capital goods, as ploughs or barns, something 
more must be done than to save wheat. The farmer could build 
the barn himself in time saved from wheat growing; or he could 
sell part of his wheat and with the money hire a carpenter to 
erect the barn. In the latter case surplus labor produces sur- 
plus wheat, which is exchanged for money, which in turn is 
saved and used to employ labor to erect a barn. Or the farmer 
might borrow the money from a neighbor or a bank with which 
to erect his barn. In which case he borrows the capital store 
of another and uses it to produce a barn for himself. Here one 
person does the saving and the other utilizes that saving in 
setting labor to work for the production of capital goods. In 
modern society the saving tends largely to be done by one set 
of persons and the production power applied by another set. 

SAVING IN MODERN SOCIETY 

Hoarding is a relic of bygone ages. Money is no longer put 
by in an old stocking or hidden under a mattress. It is plain 
that wealth stored away in this manner is not aiding in further 
production. Today money to be saved is usually deposited in 
a bank or invested. In modern societies there has grown up 
an elaborate mechanism of investment the purpose of which is 
to facilitate the transfer of the money saved into the hands 
of those who are desirous of using it for the purposes of further 
production. Savings banks throughout the country gather up 
the small savings of millions of the common people. These 



72 PRACTICAL ECONOMICS 

individual amounts are usually of little account, and their 
owners are not in a position to utilize them in further production. 
But pooled in these institutions they amount to a considerable 
sum; and in the hands of the bankers who are in touch with 
business men, a large part of this eventually is loaned 
to manufacturers and to merchants. The savings bank 
is only one part of the gigantic mechanism of invest- 
ment. Other banks, promotion companies which retail the stock 
of new corporations by salesmen direct to the small investor, 
brokerage houses, life insurance societies and other financial 
institutions — all are engaged in collecting and directing this 
flow of stored up money capital into the channels of production. 
By their aid the store of capital saved by the nation is put 
into the hands of employers who use it to set laborers to work 
to produce the costly and varied capitalistic machinery which 
renders modern production so tremendously effective. 

MAINTENANCE OF CAPITAL 

Savings and labor are necessary not only for the production 
of capital but for its maintenance. The productive equipment 
of society is continually wearing out, buildings are deteriorating, 
machines are depreciating or becoming obsolete, and it is essen- 
tial for the efficiency of production that the capital equipment 
be maintained in first class condition. Part of the savings of 
the nation must be used in the form of a replacement fund, to 
employ the labor necessary to repair and reconstruct the capital 
goods destroyed. We have already referred to the manner in 
which business men replace used-up capital goods and take care 
of the wear and tear on fixed capital by means of the deprecia- 
tion account. In replacing a worn-out machine, the business 
man does not, of course, directly employ the labor used in its 
construction; but the machine he buys has come into being 
as a result of other money capital being used to set free labor 
for its production; in like manner the raw materials used in 
its construction have been produced by still previous capital 
used in the extractive industries in the same manner. There- 
fore, in buying a machine which has been made in anticipa- 
tion of his needs, a business man is reimbursing other pro- 



CAPITAL AS A FACTOR IN PRODUCTION 73 

ducers who have borrowed money and used it to hire labor to 
the end that his machine can be replaced when worn out. 

// SUMMARY 

Capital is a derived factor in production in the sense that it is 
itself a product of nature and labor. It comprises all inter- 
mediate products used for the purpose of further production. 
These are sometimes classified as fixed and circulating capital 
goods. Those that endure for several periods of production are 
termed fixed while those whose values are completely trans- 
ferred to the product of the current period, are termed circulat- 
ing. Capital comes into existence and is maintained through 
saving and labor. 

TEST QUESTIONS 

1. Explain why capital is referred to as a "derived" factor of production. 

2. What is a good definition for capital? 

" 3. Name the eight heads under which the nation's capital goods may 
be classified. 

4. Why distinguish between capital and consumption goods? 

5. What is the distinction made between fixed and circulating capital? 

6. How does capital come into existence? 

7. How is it maintained? 



CHAPTER VII 

THE TWO IMPORTANT FUNCTIONS PERFORMED 
BY CAPITAL IN MODERN PRODUCTION 

Capital serves in production first as an instrument by means 
of which the productivity of labor is increased ; second as a store 
of wealth by means of which labor is able to be employed in the 
profitable but long-time system of modern production. 

THE EVOLUTION OF THE INSTRUMENTS OF INDUSTRY 

It has been said that what distinguishes man from all other 
animals is the fact that he is a user of tools. Certainly, placed 
in a state of nature without them he would be a most helpless 
creature. Between the flint-headed spear and the automatic rifle, 
the stone hammer and the steam hammer, there stretches a period 
of time usually estimated at 200,000 years during which man 
has risen from the condition of a creature scarce able to wrest a 
subsistence from nature to a position of supremacy as a member 
of a civilization that by virtue of its mastery over the forces of 
nature satisfles his wants on a scale so lavish that even the 
poorest enjoy comfort that kings never dreamed of. The eco- 
nomic progress of the race is in no other manner so fascinatingly 
revealed as in the evolution of the instruments used by man on 
his way from savagery to civilization. 

DEVELOPMENT OF MACHINERY 

The most important feature of this evolution has been the 
development of machinery. We might divide the history of pro- 
duction into two periods, that of the tool and that of the machine. 
The first dates from the time of primitive man to the middle of 
the eighteenth century, during which man fashioned the mate- 
rials of his work by hand with tools, many of which, like the old- 
fashioned spinning wheel of the seventeenth century England, 

74 



TWO IMPORTANT FUNCTIONS PERFORMED 75 

he had used for ages in much the same form. The second, start- 
ing in the eighteenth century with a remarkable series of me- 
chanical inventions and the application of steam power to the 
driving of these, ushered in the era of machine production which 
is in full swing today. The chief cause of the transition from 
handicraft to machine production was the invention of mechan- 
ical contrivances to operate the tools previously guided directly 
by the human hand. Just as soon as the tool is taken from the 
hand of man and placed in a mechanical contrivance, its essential 
character is changed. Man still controls it, but indirectly through 
a mechanism. It is this changed relationship between man and 
tool that constitutes the difference between a tool and a machine. 
The old-fashioned cobbler stitched his shoes by hand with a 
needle, the modern shoemaker stitches his with a needle the mar- 
velously rapid movements of which are regulated by that com- 
plicated mechanism, the sewing machine. In advancing from 
tools to machine, therefore, man devises a mechanism that 
performs with tools operations previously performed by the 
workman with his tools. Up to the year 1735 spinning had always 
been done by hand, with the aid of the spinning wheel. John 
Wyatt initiated the development of machinery in the textile busi- 
ness by the invention of a mechanical device which he described 
as a machine "to spin without fingers." This was the forerunner 
of a series of mechanical inventions that ushered in the new 
period of production by machinery. 

APPLICATION OF STEAM POWER 

Having relieved himself of the necessity of directing the tools 
he worked with by the invention of a machine, man's next step 
was to employ some greater force than his own in driving the 
machine. Only having two hands, man is limited to the number 
of tools he can handle. Not so with the mechanism of his in- 
vention, which from the outset began to outstrip him in the 
number of tools it worked simultaneously. The early develop- 
ments of machinery were chiefly along this line. Hargreave's 
spinning jenny, invented in 1764, operated twelve spindles; 
Arkwright's water frame and Crompton's spinning mule further 
increased the number. As the machines grew in size and com- 



76 PRACTICAL ECONOMICS 

plexity they demanded a greater motor power to drive them than 
man power. Wyatt used horsepower, Arkwright built a small 
factory on the banks of the River Derwent and drove his spin- 
ning frames by waterpower. Neither horsepower nor water- 
power were satisfactory; but history seems to show that what- 
ever man needs badly enough his brain supplies. And in this 
instance the urgent need for a more powerful motor force to 
drive the newly invented machines was supplied by Watt when 
in 1784 he brought to a successful completion the invention of 
the steam engine in the form of his double-acting machinery pro- 
pelling engine. (As Watt pointed out at the time, his was not an 
invention for any one purpose, but a universal agent which could 
be applied to all mechanical contrivances.) No sooner had this 
new and greater power been applied to the early textile ma- 
chines than a great stimulus was given to the invention of ma- 
chinery in all lines of industry, with the result that in England 
by the beginning of the nineteenth century the old handicraft 
system had been superseded by the new system of machine 
production. 

DEVELOPMENT OF MOTIVE POWER MACHINERY 

The substitution of a natural force, steam, for human force 
resulted in the invention of a separate mechanism to supply the 
motive power for the machine. All fully developed machinery 
consists of three parts — ^the tool, or working mechanism, the 
transmitting mechanism, and the motor mechanism. The evolu- 
tion of machinery began with the first of these, the working 
mechanism. The invention of the steam engine marked a new 
stage in its evolution, in which the development of motive power 
mechanism played a conspicuous part. The ever-increasing size 
and complexity of the working machine, the spreading of trans- 
mitting mechanisms which enabled a large number of machines 
to be driven by one motor created an ever-increasing demand for 
more powerful motive mechanism. The discovery of the new 
motor powers — gas and electricity — with the invention of the 
dynamo in 1857 and the internal combustion engine in 1876, re- 
sulted in the development of motor machinery capable of exert- 
ing gigantic power. As a result first of the invention of working 



TWO IMPORTANT FUNCTIONS PERFORMED 77 

machines, and second of the application of natural forces to the 
driving of these by the invention of motor machines, the world's 
industries in the short space of a century and a half have been 
completely revolutionized. 

HOW THE INSTRUMENTS OF INDUSTRY INCREASE 
PRODUCTION 

Capital, in its capacity of an instrument, increases the produc- 
tivity of labor by enabling man to utilize to greater advantage 
the properties of matter and the forces of nature. It accom- 
plishes this in two ways: (1) By increasing the motive power at 
man's disposal, (2) by enabling him to direct motive power more 
effectively. 

By the use of such simple mechanical devices as the lever, 
wedge, pulley, etc., man is able to exert greater power on the 
object of his labor than with his bare hands. A pole used as a 
lever enables him to move a block of stone that would otherwise 
resist his utmost efforts, just as a wedge enables him to split 
that stone at will. By placing wooden rollers beneath his stone, 
as did the Egyptians, he is able to move from place to place huge 
blocks, while by the use of wheels in a complicated mechanism 
such as a truck driven by steam or gas he transports his stone 
with ease over long distances. First, with a rock held in his 
hand, later with one fastened with thongs to the end of a stick, 
ancient man increased the power of his arm to deliver a blow. 
But with his steam hammer the modern hammerman can tap an 
egg without breaking it or flatten a steel ingot with a blow that 
would put Thor himself to shame. With microscope and tele- 
scope man has increased his power of sight; while the telephone 
and dictaphone have given new powers to his voice. 

Not only does machinery by means of mechanical devices and 
the utilization of natural forces add to human labor power, but it 
enables man to direct these powers more effectively, so that he 
performs more accurate work and work of a more delicate nature 
than he could accomplish alone. The Pratt-Whitney measuring 
machine, which decides the thickness of cigarette papers, meas- 
ures a millionth of an inch. Whenever exact and minute meas- 
urements are required, machinery outdoes the hand. One of the 



78 PRACTICAL ECONOMICS 

greatest mechanical devices is the slide-rest invented by Henry 
Maudslay early in the nineteenth century. It has been said that 
the influence of the slide-rest on industry was as great as that of 
the steam engine, which, in common with all other machinery, 
owes its perfection to this ingenious means of giving to metallic 
objects the most precise and perfect geometrical forms. The 
secret of Maudslay's service to industry was to take the tool 
from the worker's hand and place it in a mechanical rest which 
exerts a far more even and accurate pressure than human hands 
are capable of. Another phase of the directive function of ma- 
chinery is the accurate repetition of precisely identical move- 
ments and operations. Wherever continuity of movement is 
required, machinery outclasses man and as well relieves him of a 
monotonous task. 

INCREASED PRODUCTION THROUGH MACHINERY 

As a result, man by harnessing the powerful forces of nature to 
modern machines produces in greater quantity and with better 
quality products unattainable by his own unaided labor. Before 
Eli Whitney invented the cotton gin in 1793 the separation of 
the seed from a pound of cotton took on an average one day's 
labor. By means of his invention a negress was able to clean a 
hundred pounds daily, and since then, through improvements to 
the cotton gin, that amount has been increased. In speaking of 
machinery in the shirt and collar industries, a recent government 
report states: 

The great development of the wearing apparel industries, including 
men's shirts, has been coincident with the invention of special appli- 
ances and attachments adapting the sewing machine to practically all 
stitching processes, including button-hole making and button sewing. 
By these inventions not only has the cost to the consumer been reduced 
to a minimum but the product is made infinitely better. Hand labor 
has practically disappeared in the sewing of men's shirts. Buttonhole 
and button-sewing machines, with a daily capacity of from five to six 
thousand buttonholes or buttons, have replaced the laborious and 
expensive methods of hand labor. In the early stages of the industry 
the machines were run by foot power and later on by steam but now 
electricity is used almost entirely. Some of these machines attain a 
maximum speed of 3,500 stitches a minute. Button-hole making by 



TWO IMPORTANT FUNCTIONS PERFORMED 79 

hand is a tedious process, with a maximum capacity for a skilled worker 
of 7 to 8 dozen buttonholes in a 9-hour day. The machine process 
with a fairly skilled operator yields 5,000 to 6,000 buttonholes per day. 

What has happened in the shirt and collar industry is typical 
of what has occurred in most all industries in the United States. 
All along the line electrically driven machines with their steel 
hands working with marvelous power, speed, and accuracy are 
fashioning the products once made laboriously by hand ; and not 
alone the products of man's hand, but of his head. Calculating 
machines of all kinds, comptometers, cash registers, adding ma- 
chines, and bookkeeping machines, with their mechanical brains 
nerved with electricity, outstrip human brains in accuracy and 
speed. These are revolutionizing the office just as the earlier 
machines did the factory, so that the routine brain work of a 
modern office is largely performed by machinery. 

■ Not only has machinery enabled man to produce products at a 
faster rate and of a better quality, but others he could never have 
made by hand alone. Glass cannot be made from sand by hand — 
many kinds of tools and machines are necessary for its manufac- 
ture. So with iron and steel and a thousand others. Though 
nature neglected to provide man with wings, he has at last solved 
the problem of human flight with his latest machine and now 
flies higher and faster than the birds. Already the United States 
mail is being carried by aeroplane, and between the principal 
cities of Europe regular aerial transportation routes are now an 
established fact. 

THE FUTURE OF MACHINERY 

The most remarkable thing about machinery is its recency. 
What is a century and a half in the life history of mankind? Yet 
not in all the thousands of years man was a user of tools did 
changes occur in his social and industrial life to be compared 
to the revolution which has taken place during the present brief 
period of machine production. His accomplishments today in the 
eyes of his ancestors would appear miraculous. The newness of 
some of our modern inventions is rather strikingly brought to 
mind when we consider that telegraphy (1837), the oldest of the 
great electrical inventions, has sprung up within the life-time of 



80 PRACTICAL ECONOMICS 

men living today; that the dynamo (1857) is but sixty-five years 
old. It is hardly conceivable to us moderns that forty-seven 
years ago (1876) telephones did not exist; that people living 
forty-five years ago (1878) had never seen an electric light and 
that electric cars (1881) were then unknown. The fact worth 
keeping in mind is that the evolution of machinery is forging 
ahead as fast today as it ever was. Improved machinery is con- 
stantly replacing old in every branch of industry. Electricity, 
say those who know it best, is but in its infancy. If the prophecy 
of Steinmetz is fulfilled, in a few years electrical power will be as 
cheap as water. Any day may bring forth a new power which 
will eclipse those we now have. There is no reason why this 
evolution should stop. Wonderful and powerful as are the ma- 
chines of today, those of tomorrow will be more so. The changes 
of the past presage even greater changes for the future. What 
they will be no man can guess ; but their effect will be to lighten 
human labor and add to human happiness in so far as their 
benefits are distributed justly among all people. 

CAPITAL AS A STORE OF WEALTH 

Tools and machinery increase the productivity of labor, but 
they themselves must first be made, and their use involves a 
roundabout system of production, consisting of numerous inter- 
mediate stages, all of which necessitates a long period of time to 
elapse before the appearance of the finished product. Modern 
production begins with the extraction of raw materials and the 
making of machinery involves extensive transportation, nu- 
merous processes, and is carried on in anticipation of demand. 
It is here that capital comes to the rescue in its capacity of a 
store of wealth to supply the producers with the means of sub- 
sistence while they expend their labor in this profitable but long- 
time system of production. It is this element of time in modern 
production that is at the bottom of the dependence of the laborer 
on the capitalist. The laborer, unable to wait until the finished 
product of his labor arrives by the roundabout process, becomes 
dependent on the capitalist, who holds in his possession the means 
without which the productive enterprise cannot be carried out. 
It is evident that an individual or a community of individuals, 



TWO IMPORTANT FUNCTIONS PERFORMED 81 

without any stock of goods saved up from past industry, would 
be forced to live from hand to mouth and would gain but a bare 
existence; it is only after they have accumulated a surplus that 
they would be able to devote their energies first to the making of 
plant and machinery and then to making with these the com- 
modities they desire. 

GROWTH OF CAPITAL 

Under the handicraft system the amount of capital required 
was small, but with the rise of machine production capital has 
come to be demanded in larger and larger quantities. The total 
manufacturing capital in the United States has grown from 
$533,000,000 in 1849 to $18,428,070,000 in 1909. In 1850 the 
average number of employees per manufacturing establishment 
was seven and the average capitalization $4,330. In 1910 the 
average of employees increased to 25, and the capitalization to 
$68,638, an increase of 1,485 per cent in capital to one of 225 in 
labor. The striking fact revealed by these figures is the remark- 
able increase in the amount of capital used by the average con- 
cern in comparison to the small increase in its labor force. The 
figures also illustrate the growing tendency toward large-scale 
production, which is the outgrowth of the development of ma- 
chinery and division of labor. The economical utilization of 
machinery and division of labor make necessary a large output. 
The economies due to large-scale production have tended to 
concentrate production in fewer and bigger establishments. This 
tendency is particularly evident in the iron and steel industry, 
which not only supplies the materials out of which machinery is 
built, but which uses gigantic machinery of all kinds to produce 
these materials. In 1850 there were 468 iron and steel plants in 
the United States. In 1910 there were 654; the average number 
of employees in 1850 was 53; in 1910, 426; the average capital 
of an iron and steel plant in 1850 was $46,700, while in 1910 the 
average capital had increased to $2,282,000; in the same period 
the product increased from $43,000 to $2,119,000. The number 
of establishments has increased but 40 per cent, while the prod- 
uct has increased 4,700 per cent. The notable feature, however, 
is the tremendous increase in capital for the average steel plant. 



82 PRACTICAL ECONOMICS 

COMPLEMENTARY NATURE OF CAPITAL AND LABOR 

One of the most prominent rubber manufacturers said recently 
to an interviewer: "All the millions of dollars we have invested 
in this plant wouldn't be worth a cent if they were not vitalized 
by human effort." He might just as truly have said, "All the 
labor of the 20,000 men in this plant wouldn't be worth a cent 
if they were not equipped with capital." Both statements are 
equally true and reveal the complementary nature of the two 
factors, labor and capital. Either alone is impotent, together 
they are all powerful. Take the case of this particular producer. 
In 1898, believing there was a future in the rubber business, but 
having no money of his own, he borrowed the necessary capital, 
$13,500, organized a company, bought a small factory building, 
and started in to make rubber carriage tires. In the early days 
of its history the company had pretty hard sledding owing to 
insufficient capitalization; people didn't have much faith in the 
rubber business in those days, and it was only by the exercise of 
extraordinary ingenuity and perseverance that the increasing 
demands for capital were met. In 1917 the net assets of this 
company amounted to $60,000,000. It owns one of the finest 
plants in the world, equipped with the latest and most efficient 
machinery for manufacturing all kinds of rubber product. It 
has acquired 20,000 acres of rubber lands in Sumatra and 24,000 
acres of desert in Arizona that are being reclaimed for growing 
long-staple cotton, and also owns a cotton mill in Connecticut. 
Its sales for 1917 reached $111,000,000. 

IMPORTANCE OF CAPITAL 

It is not alone efficient labor and abundant raw materials that 
result in industrial efficiency, but also quantity production 
coupled with the use of labor-saving machinery. That concern, 
other things being equal, which is equipped with the most efficient 
machinery, will produce the largest product at the lowest unit 
cost. To the individual and the nation alike, capital in its two- 
fold capacity is an essential factor in the economic struggle for 
existence. It is obvious that a nation cannot engage in the build- 
ing of railroads, canals, harbors, irrigation plants, and other 
profitable but time-consuming projects without capital. It is 
equally plain that a nation whose industries are poorly supplied 



TWO IMPORTANT FUNCTIONS PERFORMED 83 

with obsolete machinery will be unable to compete successfully 
with another supplied with a modern and superior equipment. 
The coming international economic struggle will hinge on ma- 
chines, and the capital wealth necessary to purchase them and 
utilize them in quantity production. 

TEST QUESTIONS 

1. What two distinct functions does capital perform in our economic 
system? 

2. What part has the evolution of the instruments of production played 
in furthering human progress? 

3. Wherein lies the difference between a tool and a machine? 

4. What three stages mark the evolution of the instruments of 
production? 

5. In what two ways does capital in its capacity of an instrument of 
production increase the productivity of labor? 

6. Give an illustration of the superiority of machine production over 
hand labor. 

7. How does capital facilitate production in its capacity of a store of 
wealth? 

8. Give some idea of the growth of capital in the United States in the 
last half century. 

9. Make clear the relationship between labor and capital in production. 
10. Give some idea of the importance of capital in our present indus- 
trial system. 

REFERENCES 

Bohm-Bawerk, E. von, Positive Theory of Capital. 
Carey, M., Pohtical Economy (Part 1, Chap. XIX). 
Carver, T. N., Principles of Political Economy (Chap. XIII). 
Clay, H., Economics for the General Reader (Chap. V). 
Fetter, F. A., Economic Principles (Chap. XXII). 
GiDE, C, Political Economy (Book 2, Chap. III). 
Hadley, a. T., Economics (Chap. V). 

Marshall, A., Principles of Economics (Book II, Chap. JV). 
Nicholson, J. S., Principles of Political Economy (Chap. VI). 
Say, J. B., Political Economy (Book 1, Chap. III). 
Seager, H. R., Principles of Economics (Chap. IX). 
Smith, A., Wealth of Nations (Book 2, Chaps. I-V). 
Taussig, F. W., Principles of Economics (Chap. V). 

Trowbridge, W. P., Report on Power and Machinery Employed in Manu- 
factures' Industrial Qsmmission, Report XIX, 1902 (514-544). 
Veblen, T. B., Theory of Business Enterprise (Chaps. II, IX). 
Walker, F. A., Political Economy (1888, Part 2, Chap. Ill), 
U. S. Twelfth Census, VII. 



CHAPTER VIII 

ORGANIZATION AS A FACTOR IN PRODUCTION 
ORGANIZATION IN PRODUCTION 

We live today in an age of organization. The achievements of 
the present are the result of organized effort. The individual 
working for himself has given away to the combination of indi- 
viduals working together for a common purpose. Individual 
action has been replaced by collective effort. We find this evi- 
denced in all spheres of human activity, political, social, and 
religious, but it is in industry that organization has achieved its 
most remarkable results and is found in its most highly devel- 
oped state. There is scarcely a thing we use from the time of 
rising in the morning to retiring at night which is not the product 
of some organization. The bed we sleep in, the soap we wash 
with, the clothes we wear, the food we eat, the car that whirls us 
to and from our place of business, the telephone on our desk, all 
alike are the result of organized effort, and moreover without 
organization they would not be produced at all. In organization 
we moderns live, move, and have our economic being. 

REASON FOR ITS INCLUSION AS A FACTOR IN 
PRODUCTION 

Following the lead of Adam Smith, it has been customary to 
consider land, labor, and capital as the sole factors of production 
Since the time when he wrote his famous "Wealth of Nations" 
changes have occurred which seem to make it advisable to segre- 
gate organization as a separate factor in production. The indus- 
trial systems of the leading countries of the world have evolved 
a complexity of structure compared to which that of the time of 
Adam Smith seems simple. New problems have arisen, intricate 
problems, urgent problems on the solution of which hangs the 
happiness of the workers ^nd the welfare of the nation. Large- 

§4 



ORGANIZATION AS A FACTOR IN PRODUCTION 85 

scale production incurring the use of tremendous sums of capital 
invested in quantities of modern machinery entailing the employ- 
ment of an army of workers engaged in a multiplicity of varied 
activities, all operating under a central control, have brought 
into prominence the economic unit itself, which in the course of 
its evolution has developed a size and complexity of structure 
worthy of special consideration. The productivity of any nation 
today depends as much on the character of its business organi- 
zations as on its natural resources, its labor force, or its capital; 
for it is only through the former that the latter three are united 
for effective production. There is a more urgent need today for 
a close study, an accurate knowledge, and a clear understanding 
of the underlying principles of business organization than at any 
other period in the country's history. To place it in the position 
of a separate factor of production will single it out for attention 
and study. 

ORGANIZATION DEFINED 

In the separate discussion of land, labor, and capital we have 
naturally enough emphasized their individual imporL^mce. It is 
just as necessary to realize their absolute interdependence. Un- 
der our modern industrial system with its large-scale production 
and division of labor, either factor by itself is comparatively 
helpless; only when working together are they effective. It fol- 
lows, therefore, that the structural unit by means of which they 
are combined for effective production is performing a highly im- 
portant function. Organization as a factor in production may be 
defined as an arrangement of land, labor, and capital for the 
purpose of producing commodities or services. Every business 
concern is such an arrangement. 

THE ESSENTIALS OF ORGANIZATION 

What are the dominant characteristics, the fundamental fea- 
tures of organization in general? A grasp of these will give us a 
keener insight into the nature of business organization. Organi- 
zation has been variously defined as follows: "The act of arrang- 
ing or an arrangement of related or interdependent enterprises 
into a group with such system as will enable and make it possible 



86 PRACTICAL ECONOMICS 

to compel each to cooperate harmoniously with the others in the 
accomplishment of a common end." "A harmonious arrange- 
ment of specialized parts for the accomplishment of a common 
purpose" — "a living structure composed of organs" — "a syste- 
matic union of individuals into a body whose officers, agents and 
members work together for a common end." An analysis of 
these definitions shows that all organizations involves, first, an 
arrangement; second, specialized parts; third, some form of cen- 
tralized control; fourth, a common end or purpose. In short the 
essentials of organization are: 

1. Arrangement. 

2. Specialization. 

3. Centralization of control. 

4. Unity of purpose. 

ARRANGEMENT 

An organization is an arrangement, a contrivance. To organize 
is to arrange and on the arrangement depends the successful 
operation of the organization. The object of arrangement is co- 
ordination. The interdependent parts of which the organization 
is composed must be so placed that their activities coordinate. 
In the human body, the parts are so related that they coordinate 
perfectly, each performing its function in the general scheme of 
things and all working together for the common good. The 
organs of the digestive system— mouth, tongue, oesophagus, 
stomach, and intestines — are so combined that together they 
function to digest food. In the same way the departments 
of a factory are so arranged that together they function to manu- 
facture a product. But while in the human body the arrange- 
ment is contrived by nature and the organism comes into being 
already developed, in the business organization the arrangement 
is undertaken by man, who must perform the work of construc- 
tion. His raw materials are land, labor, and capital, in the form 
of men, money, machinery, materials, and plant, and his problem 
is to arrange them in such a manner that they function to pro- 
duce commodities or services. The departments of a manufac- 
turing plant, for instance, must be so related that the raw mate- 
rials which enter at one end pass from department to department 



ORGANIZATION AS A FACTOR IN PRODUCTION 87 

without any back handling till shipped out as finished products 
at the other. Men and machinery must be so coordinated that 
they work together to the best advantage. Time and motion 
study work consists largely of an arrangement between the man, 
the material, and the machine; the position and the motions of the 
worker are so ordered that the job is done in the shortest time 
with the least expenditure of effort. This is scientific organiza- 
tion of the job — an arrangement based on systematic observation, 
not on rule-of-thumb or guesswork. Organization throughout is 
a matter of arrangement. 

SPECIALIZATION 

In this arrangement nothing is more vital than the specializa- 
tion of its parts. An organization does not consist of one indi- 
vidual, but of a number of individuals; it is not a homogeneous 
-whole but a heterogeneous whole composed of different parts. 
This is true of every kind of organization, whether it be an 
animal organism, a baseball team, or a business corporation. In 
each the end or purpose is accomplished by a number of differing 
individuals or parts, each adapted to execute some particular 
activity. In the animal organism the eye does the seeing, the 
ear the hearing, and the feet the walking; in the winning of the 
baseball game each member of the team has his special work 
of catching, pitching, or fielding; and in the business corporation 
each department has its own special function; the sales depart- 
ment is organized to take care of the selling activities, the pur- 
chasing department does the buying, and so on. A specialization 
of parts based on functions is of the very essence of all organiza- 
tion. In animal organisms, as we have noticed, the higher the 
organism in the scale of life the more highly specialized are its 
parts. The same law applies to business organizations which 
have evolved from the individual producer who carried out all 
of the simple functions of business himself to the most modern 
development, the big corporation with its numerous highly spe- 
cialized departments, machinery and workers. In organization 
specialization is synonymous with progress. The most efficient 
business organizations are those in which specialization of de- 
partments — men, machinery, and equipment — has been carried 



88 PRACTICAL ECONOMICS 

to a high degree. The work of organizing is largely a matter of 
this specializing; first, in determining the divisions and depart- 
ments best adapted to the carrying out of the various activities 
and then in the building up of these with specialized men, ma- 
chinery and equipment. Specialization, therefore, is a funda- 
mental principle of organization. 

CENTRALIZATION OF CONTROL 

As an organization consists of a number of separate parts, 
some means of centralized control is essential to secure the co- 
ordination of their activities in the accomplishment of the com- 
mon end. All kinds of organization possess some form of cen- 
tralized control. Provision for this office is the predominating 
feature of modern business organization. In man the cerebrum, 
the throne of the mind, is the center of control; in it dwells the 
" I," the " thinker," who through the lower nerve centers directs 
all the members of the body according to his will. In the business 
corporation the center of control is the board of directors; from 
this body the control passes to the executive department, the 
general manager, and from him down through the whole organi- 
zation. This principle of centralization of control is carried out 
through every part of the organization. The control of each de- 
partment is centralized in the head of that department just as 
that of the whole organization centers in the board of directors. 
The more highly specialized the organization, the more numerous 
its parts, the more complex it is, the more necessary is some form 
of centralized control to secure unity of action. 

UNITY OF PURPOSE 

Arrangement, specialization and centralization of control are 
all means for achieving the purpose for which the organization 
was brought into being. Each part of the organization exists 
solely for the sake of contributing in some special way to the 
accomplishment of this common end. In a steel plant, every de- 
partment, every building, every machine, and every man is there 
to help make steel. The making of steel should be the common 
tie that binds them into a working whole. A great deal of fric- 
tion and waste effort would be avoided in business concerns today 



ORGANIZATION AS A FACTOR IN PRODUCTION 89 

were the common aim more clearly kept in mind by the separate 
departments and individuals. Unity of purpose inspires coop- 
eration and is essential to all organized effort. 

FORMS OF BUSINESS ORGANIZATION— THE SOLE 
PROPRIETORSHIP 

The simplest form of business organization is the one-man 
business concern, often called tl.e sole proprietorship. One man 
owns and controls the whole undertaking. It is the parent form 
of business organizations, and in its crudest state way back in 
primitive times one man not only owned and controlled the busi- 
ness but performed all of its various functions himself. In its 
more highly developed state it appears as a highly specialized 
organization owned and controlled by one man, as the John 
Wanamaker and Marshall Field stores were previous to their 
incorporation. It was the typical form of organization of the 
handicraft system in the middle ages and is the prevailing type 
today in farming, retailing, and in the professions. In 1900 
there were 171,000 establishments under individual ownership 
forming 63 per cent of all establishments. In 1904 the number 
had dropped to 113,900 and 63 per cent of the total. In 1909 the 
percentage of the total was 52 per cent. The value of the prod- 
ucts produced by individually owned establishments shows the 
same tendency, falling from 16 per cnet in 1900 to 12 per cent in 
1904 and to 10 per cent in 1909. 

The advantages of the sole proprietorship form are: (1) Ease 
of starting; no articles of agreement need to be drawn up or 
certificate of incorporation obtained; (2) close relationship be- 
tween interest, authority and responsibility — the person who has 
everything to lose or gain by the management of the business has 
that management entirely in his hands. This acts as a direct 
check on waste and is an incentive to efficiency; (3) centraliza- 
tion of control allows a promptness and facility of action not as 
easily attained in a complicated organization. Its disadvantages 
are: 

1. The one individual lacks the breadth of knowledge and 
ability contained in the personnel of the partnership or 
corporation. 



90 PRACTICAL ECONOMICS 

2. Difficulty in raising sufficient capital. 

3. The unlimited liability of the sole owner for the debts of 

the business. 

THE PARTNERSHIP 

With the introduction of machinery and the spread of division 
of labor, there was a gradual development of the business in size 
and complexity of structure. It became increasingly difficult for 
one man to raise sufficient money or to assume the control and 
direction of the larger quantities of men, machines, equipment, 
and plant demanded by the enlarged unit. The sole proprietor- 
ship was thus supplemented by the partnership form of organiza- 
tion, wherein two or more individuals formed an association for 
the purpose of conducting a business, sharing in the ownership 
and control according to an agreement among themselves. 

Like the sole proprietorship, the partnership has the advantage 
of facility of formation; there is also a direct relationship be- 
tween effort and reward which acts as a stimulus to efficient man- 
agement by the owner. It possesses an advantage over the single 
entrepreneur form in that the combined ability of several heads 
allows some degree of specialization in control and management 
and also its borrowing capacity enables it to raise larger sums 
of capital. It lacks the centralized control of either the sole 
proprietorship or the corporation. 

This divided control has often been a serious disadvantage in 
partnerships, causing lack of harmony and unity of action. 
Though able to raise larger sums of capital than the single entre- 
preneur, its capacity in this direction is inferior to that of the 
corporation. Liability to disruption is another disadvantage to 
the partnership which may take place by the death, insolvency, 
or withdrawal of one of the partners. Finally, the unlimited lia- 
bility of the partners for debt is a decided disadvantage to the 
partnership form of organization. 

THE CORPORATION 

As a result of a long process of evolution from the individual 
entrepreneur the partnership and a transition from the joint stock 
company, rarely found in the United States though still common 



ORGANIZATION AS A FACTOR IN PRODUCTION 91 

in Great Britain, we have arrived at the corporation, which is 
the prevailing type of organization today. About 80 per cent of 
the manufactured products of the United States are produced by 
corporations. The corporation comes into existence and is main- 
tained by virtue of the general state corporation acts. Under 
such an act any citizens who meet the requirements of the law 
may form a corporation by drawing up according to form a char- 
ter or certificate of incorporation, on the acceptance of which by 
the proper officer of the state the corporation comes into being. 
It is thus a creature of the state, its certificate of incorporation 
is its birth certificate wherein its powers are defined and cer- 
tain rights granted. It is a legally constituted association of 
individuals authorized by law to conduct business as a single 
entity. 

The advantages of the corporation are: 

1. Greater permanency; the individual members may die or 

retire, but the corporation continues its existence as a 
distinct entity. 

2. Limited liability; the liability of each stockholder is 

usually limited to the amount he has invested in the 
company. 

3. Facility for raising large amounts of capital by selling 

the capital stock to numerous small shareholders. The 
tremendous sums of capital required by large-scale pro- 
duction can be raised. 

4. Centralization of control and direction — the binding legal 

constitution of the corporation with its provision for 
the ^ concentration of control in the board of directors 
makes for unity of action. 

There are several disadvantages of the corporation form. Its 
formation necessitates the expense and formality of filing a cer- 
tificate oi incorporation with the state. Its powers are restricted 
to the definition of its purpose in this document. It is subject to 
stricter supervision and regulation than the sole proprietorship 
or the partnership. Through the separation between ownership 
and management which occurs in the large corporation, the spur 
to efficient management is often dulled. 



92 PRACTICAL ECONOMICS 

INTERNAL ORGANIZATION OF A CORPORATION 

We have discussed the chief forms of organization mainly from 
the viewpoint of ownership and have noticed their external char- 
acteristics. We will now glance at the internal arrangement of a 
typical corporation. Commencing with the big divisions and 
working down, we find the corporation to be divided into two 
main parts, one of which is devoted chiefly to administrative 
affairs and is termed the corporate or administrative organiza- 
tion; the other, devoted to the direct production of the com- 
modity or service, is usually called the operating or production 
organization. Both, of course, are concerned in the production 
of the commodity and both exercise administrative powers, but 
each is np-med after its predominant function. 

THE CORPORATE OR ADMINISTRATIVE ORGANIZATION 

The purpose of the administrative organization is .to control 
and direct the affairs of the whole corporation on behalf of its 
owners, the stockholders. It is the means by which the stock- 
holders exercise their functions of ownership — and control. It 
constitutes the governmental structure of the corporation and 
consists of the stockholders, the board of directors, the executive, 
the general manager. The body of stockholders represents the 
ownership of the corporation, and is the ultimate source of 
authority and control. Then come the board of directors elected 
by the stockholders and endowed by them with full authority 
to control and direct the affairs of the corporation. The board 
of directors is thus the center of control and direction for the 
corporation as a whole. It carries out its policies and plans 
through its executives. The executive department exists to exe- 
cute the directions of the board. In the smaller corporation the 
chief executive is the president who exercises full supervision 
over the business and is directly responsible to the directors. 
In the larger corporation there is usually an executive committee, 
the chairman of which is the chief executive. Other executive 
officers are the secretary and treasurer. The general manager 
is often classed with the operating organization; his function, 
however, is administrative. He is the connecting link between 



ORGANIZATION AS A FACTOR IN PRODUCTION 93 

the two organizations. He is appointed by the president or the 
directors and is responsible for the success of the operating or- 
ganization. He is the center of control and direction for the 
operating division and his function is to correlate the various 
departments, coordinate their activities, so that all the parts 
work smoothly and efficiently together to turn out the largest 
amount of product at the lowest unit cost. 

THE OPERATING ORGANIZATION 

While the direct object of the corporate organization is the 
general administration of the affair of the company, that of the 
operating organization is the production of the commodity or 
service for which the corporation was formed. To accomplish 
its purpose in the most efficient manner, the operating division 
is divided into four main departments, the production depart- 
ment, the sales department, the financial and the accounting 
departments, which correspond with the four universal functions 
of business. Every concern is producing a product whether it 
be some concrete commodity such as steel, shoes or locomotives 
or some intangible thing such as transportation, a bank's service 
to its depositors or a store's service to its customers which neces- 
sitates, first, the buying of some commodity. 

The actual making of the product is the primary object, and 
the internal organization must, therefore, contain a department 
to perform the service or to carry on the work of manufacture, 
to secure the raw material and work it up into its finished state. 
The product is of no use lying in the factory, it must be sold. 
The selling function varies in importance in different kinds 
of business, but is present in all in some degree. A well-organ- 
ized sales department is a vital necessity to the modern corpo- 
ration. No less so is a good financial department. Manufac- 
turing and selling cannot be carried on without money. The 
financing of a business in this capitalistic age is no mean task, 
and demands specialized ability. A separate department is 
required to take care of financial operations, to procure funds, 
collect debts and disburse moneys. Last but not least, is the 
function of accounting. A record must be kept of all the transac- 
tions of the business, of all expenses and income, otherwise affairs 



94 PRACTICAL ECONOMICS 

would end in hopeless confusion. The accounting department 
attends to the recording of business transactions, evidences the 
assets and liabilities, summarizes the income and expenses, and 
submits such other financial and statistical statements as the 
executives can use. 

These four departments which are included in a typical operat- 
ing organization are further divided into those sub-departments 
and sections best fitted to handle their varied activities. The 
sales department may include an advertising department, a 
correspondence department, a training division or whatever 
others are necessary to carry out most effectively the selling 
plans of the company. No two organizations are exactly alike. 
The number and arrangement of the departments wiir depend 
on the nature of the work to be done. If this principle of division 
based on functions be carried out through the entire organiza- 
tion from the main division, through the departments and sub- 
departments to the men and machines, labor and capital will 
be most economically employed and every individual will be 
performing that special function for which his special ability 
fits him. This division must be accompanied by such an ar- 
rangement that the separate activities of these specialized parts 
coordinate perfectly. Unity of action will be secured by cen- 
tralization of control and cooperation inspired by the common 
purpose. The complete organization may be likened to a wheel, 
the hub of which represents the corporate organization from 
which control radiates through the spokes to the rim which 
represents the operating division. This arrangement illustrates 
the central position of the general manager, who through his 
four department managers directs and coordinates the activities 
of the various departments and sub-departments of his entire 
organization. 

SUMMARY 

Organization is the keystone of the arch of production. By 
it, the other factors — land, labor and capital — are locked into a 
productive unit. Alone these others are helpless; only when 
combined in some form of organization are they capable of 
effective action in our modern industrial system. Business or- 



ORGANIZATION AS A FACTOR IN PRODUCTION 95 

ganization, therefore, demands special attention; the best brains 
of the nation should be focussed on its problems and its prin- 
ciples. Organization means arrangement; it involves speciali- 
zation of parts which in turn necessitates centralization of con- 
trol, to coordinate the functions of the parts and to secure 
unity of action, for the attainment of the common purpose. 
Arrangement, specialization, centralization of control, and unity 
01 purpose — ^these are the root ideas of organization. From 
the standpoint of production a business organization is an ar- 
rangement of men, money, machinery and materials for the 
purpose of producing a commodity or service. The chief forms 
of business organization are the sole proprietorship, the part- 
nership and the corporation. The internal organization of a 
corporation is based on functions. The work of the corporation 
is divided and sub-divided into separate activities and special 
departments are created to discharge these activities. Harmony 
of action is induced by centralization of control. 

TEST QUESTIONS 

1. What is a business organization? 

2. State the four essentials of organization. 

3. What part does arrangement play in organization? 

4. What is the relation of specialization to organization? 

5. Of what importance is centralization of control in organization? 

6. What are the chief forms of business organization? 

7. State the advantages of the corporation form of organization; its 
disadvantages. 

8. Draw a chart showing the chief parts of a typical business corporation. 

9. What is the function of organization as a factor in production? 



CHAPTER IX 

LARGE-SCALE ORGANIZATION 
DEVELOPMENT OF THE CORPORATION 

The corporation which as we have seen, permits a greater 
degree of specialization and integration than p^e^'ious forms 
of business organization, has itself imdergone changes in size 
and form. It is estimated that in 1800 there were one himdred 
corporations in the United States. But the era of the corpora- 
tion as we know it today did not set in till after the ciAdl war. 
In 1915, according to the report of the commissioner of internal 
revenue, there were 299.445 corporations. Since 1870 there has 
been a remarkable development of the corporation form of or- 
ganization both in size and complexity of structure. The growth 
of large scale production which has been made possible by the 
widening of the market and by the bringing together imder the 
centralized control of the corporation, ever larger quantities 
of men. money, machinery and materials, has resulted in an 
extension of the corporation form into the holding company and 
merger. 

The holding company which appeared in 1897, and which is 
the dominant form of large corporations today, is a combina- 
tion of smaller corporations, the stocks of which it acquires 
either in whole or in part, sufficient to give it control of the 
constituent companies. Centralization of control is thus se- 
cured through the board of directors of the holding company. 
In the merger, which began to assimie importance about 1905, 
the stock of the constituent companies is brought in and can- 
celled, the only stock being that of the owning corporation. 
This represents the last stage in the development of corporate 
combination, wherein the combined companies completely lose 
their identity in the parent company and a unified and central- 

96 



LARGE-SCALE ORGANIZATION 97 

ized organization results. The earlier corporations were asso- 
ciations of individuals into a simple organization; the big cor- 
porations of today are associations of already organized indi- 
viduals or corporations into compound organizations. The trend 
of development has been from the simple to the complex 
corporation. 

DEVELOPMENT BY COMBINATION 

The most modern stage phrase of corporate development has 
come about as a result of a process of combination. The first 
period of development consisted of an internal gro-v\'th and ex- 
pansion of the simple corporation which rapidly increased in 
size. The process of combination by means of which these 
enlarged units have been compounded into the gigantic corpo- 
rations of the day, has proceeded along two different lines usu- 
ally termed horizontal and vertical. By horizontal combina- 
tion is meant the union of firms making the same kind of 
products, as, for instance, in the tobacco industry there is a 
combination of firms making cigarettes, and another of those 
producing tobacco. 

In vertical combination firms engaged in different stages 
of production are united under one management, as in the United 
States Steel Corporation, which includes companies engaged 
in the extraction of raw materials, ore and coal companies; 
coking concerns; railroad and steamship companies; makers of 
pig iron and crude steel products; and lastly finishing concerns. 
Vertical combination is in reality integration, a coordination of 
related or interdependent activities into one organic whole. As 
used in economics integration may be defined as the process 
whereby the owners of an enterprise secure a more or less 
complete control of all the steps of production, from the ex- 
traction of the raw materials to the marketing of the finished 
product. In most industries, specialization has resulted in the 
different stages of production being conducted by separate com- 
panies. In the steel industry separate concerns carried on ore 
mining; others smelted the ore into pig iron. Still others mined 
the coal and made it into coke. The pig iron producer sold his 
product to the puddler or steel maker who in turn sold his crude 



98 PRACTICAL ECONOMICS 

steel or iron to the makers of finished products. Vertical com- 
bination or integration is the process whereby these specialized, 
yet interdependent concerns are welded into one unified organi- 
zation which controls and coordinates all of the essential activi- 
ties of production from the mining of the raw material to the 
marketing of the finished product. 

LARGE-SCALE ORGANIZATION IN THE STEEL BUSINESS 

In the march of events in the steel industry, leading up to 
the formation of the United States Steel Corporation, we are 
able to see the action of combination on a gigantic scale. The 
early conditions existing in the steel industry were well told 
by Percival Roberts in his testimony in connection with the 
case of the Steel Corporation.^ Mr. Roberts said that the firm 
of A. & P. Roberts, with which he became connected in 1876, 
was started by his father and another in 1852 with a capital 
of only $8,000, which was considered sufficient in those days 
to start a works for producing wrought iron; practically all 
rolled products were made of wrought iron which was pi-oduced 
in puddling furnaces; that a puddling furnace had a capacity 
of about four tons of muck bar in twenty-four hours and was 
operated by four men; that there was no continuity of opera- 
tions in those days, that after the pig iron had been made in the 
blast furnace, it was shipped to the rolling mill where it was 
charged cold into a puddling furnace, and converted into "muck 
bar" which again was permitted to become cold after which it 
was cut into various sizes; then reheated and rolled into 
finished products. He said that in 1876 the total production 
of pig iron in the United States was less than 2,000,000 tons per 
annum, as against nearly 30,000,000 at the present time. 

He said that in 1885 two Englishmen, Thomas and Gilchrist, dis- 
covered that it was possible to remove phosphorus from pig iron during 
the manufacture of steel by the use of lime in the heating furnace; that 
this discovery practically revolutionized the iron industry and that by 
the year 1890 steel had practically supplanted wrought iron for com- 
merical purposes. That in the late eighties the introduction of elec- 
tricity as a motive power so transformed the industry that all works 

1 United States of America and U. S. Steel Corp. — Argument. 



LARGE-SCALE ORGANIZATION 99 

had to be rebuilt if the manufactuter desired to keep abreast of the 
recent developments of the art; that a little later the Jones mixer, which 
enabled the production of steel to- be carried on as one continuous oper- 
ation from the ore to the finished product, never permitting the mate- 
rial to become cold until it reached the final marketable shape, again 
materially changed the situation. He said that these changes increased 
the economic unit of manufacture from a group of puddling furnaces, 
having a capacity of forty tons in twenty-four hours, to a steel works 
having a capacity of a thousand tons in the same time. 

The gradual growth of the individual plants due to the tech- 
nical improvements mentioned by Mr. Roberts, was followed by 
a period of lateral combination, culminating between 1898 and 
1900 in a series of giant consolidations with capitalizations rang- 
ing from $30,000,000 to $100,000,000, each constituting a union 
of concerns manufacturing a like or related product. These 
'may be divided into two groups, the primary group, consisting 
of concerns engaged in the production of iron ore, and the crude 
and semi-finished steel products, chief among which were, the 
Lake Superior Consolidated Iron Mines Company; the Carnegie 
Company; The Federal Steel Company and the National Steel 
Company. The second group contained the manufacturers of 
finished steel products. The majority of the tin plate plants 
were united in the American Tin Plate Company, incorporated in 
New Jersey in December, 1898, with a capitalization of $46,000,- 
000. The American Steel and Wire Company, which was organ- 
ized a month later with a capitalization of $90,000,000, secured 
all of the leading concerns producing wire nails and wire prod- 
ucts. The other great consolidations of the secondary group 
were the National Tube Company, the American Steel Shop, 
the American Sheet Steel Company, and the American Bridge 
Company, each of which likewise was a combination of the 
leading concerns in its particular branch of the business. 

The next step was taken when these huge concerns began to 
integrate, each endeavoring to attain independence by linking 
up under its control all of the successive stages of steel mak- 
ing from the mining of tlie ore to the marketing of its finished 
products. For great as these corporations were, they were by 
no means self-sufficient. Up to 1898 there had been little inte- 



100 PRACTICAL ECONOMICS 

gration in the steel business with the exception of the Carnegie 
and Federal Companies. Andrew Carnegie, back in the eighties, 
had shrewdly foreseen its advantages, with the result that the 
Carnegie Company was highly integrated, so also was the 
Federal, but neither sufficiently to cope with the extraordinary 
situation that arose in 1900. The large steel making companies 
finally recognized the paramount importance of securing an 
adequate supply of raw materials, and by 1900 the bulk of the 
ore deposits and coking coal gravitated into the possession of 
less than a dozen concerns. These companies, though highly 
integrated on their raw material side, depended on the finished 
steel concerns to purchase their semi-finished products. On the 
other hand, the finishing concerns did not produce their own 
steel but purchased it from the crude steel making companies. 
The movement of integration was by no means destined to be 
a peaceful one. In their efforts to link up the chain of produc- 
tion the giants began to invade each other's territory. The 
finished steel products companies began to reach back and se- 
cure ore deposits and to erect crude steel plants. The crude 
steel concerns, thus deprived of a market for their steel by their 
former customers turning rivals, began preparation for the 
erecting of finishing plants. The situation in the spring of 
1901 was exceedingly grave and a steel war on a colossal scale 
with all its ruinous competition and wasteful duplication of 
plant was imminent. Matters reached a crisis on the threat 
of the Carnegie Company to erect a huge tube plant on the shore 
of Lake Erie near Conneaut. With amazing swiftness war was 
averted and the integration movement reached its climax on 
April 1, 1901, by the organization of the United States Steel 
Corporation in which these warring yet interdependent concerns 
were combined in one enormous completely integrated corpo- 
ration, with a capitalization of $1,402,846,817, possessing ore 
deposits estimated to contain about 700,000,000 tons of ore, 
50,000 acres of high grade coal lands; limestone and natural gas 
companies; 1,000 miles of railway; steamship companies; blast 
furnaces and crude steel works with an annual capacity of 
9,400,000 tons of crude steel, rolling mills and finishing mills 
of various descriptions. 



LARGE-SCALE ORGANIZATION 101 

CAUSES OF LARGE-SCALE ORGANIZATION 

The causes responsible for large-scale organizations in gen- 
eral are well illustrated in the events in the steel industry which 
culminated in the formation of the United States Steel Corpora- 
tion. The most powerful driving force is desire to escape ruin- 
ous competition. Undoubtedly the desire to restrict competi- 
tion was an active factor in the combination movement in the 
steel business. All through the nineties competition had been 
extremely keen and, as was stated at the hearings of the United 
States Steel Corporation, the nineties were strewn with the 
wrecks of concerns not able to weather the destructive competi- 
tion which ran riot in that period. Various attempts were made 
through pools and agreements to modify this competition with- 
out much success, and it no doubt played an important part in 
the formations of the earlier consolidations. Previous to 1898 
competition was between like concerns, lateral competition it 
might be termed. When, however, the bulk of the steel business 
had been concentrated into the hands of a dozen giant con- 
cerns, and these began to integrate, a vertical competition set 
in, as we have seen, of a very destructive type. Some idea of 
the virulence of this competition may be gained by a peep 
at some of Mr. Carnegie's letters written at this critical 
period. On December 30, 1898, he wrote his partners in part 
as follows:^ 

In the case of this Tin Plate Company, as in the case of the American 
Wire Company, . if our president steps forward at the right time and 
informs those people that we do not propose to be injured, on the 
contrary that we expect to reap great gains from it that we will observe 
an "armed neutrality" as long as it is made to our iiiterest to do so, 
but that we require this arrangement, then specify what is advantageous 
to us, very advantageous, and he will get it. If they decline to give 
us what v/e want then there must be no bluff. We must accept the 
situation and prove that if it is fight they want here we are "always 
ready." Here is a historic situation for the managers to study. Riche- 
lieu's advice: "First, All means to conciliate; failing that all means 
to crush." Shakespeare has it: "First in your right hand carry gentle 

^United States of America and U. S. Steel Corp. Brief for United States, 
page 270. 



102 PRACTICAL ECONOMICS 

peace; but after peace is gone the worst policy in the world is gentle 
war." 

On July 7, 1900, Mr. Carnegie cabled as follows: 

My recent letters predict present state of affairs; urge prompt action 
essential; crisis has arrived, only one policy open, start at once hoop, 
rod, wire and nail mills, no half way about last two. Extend coal and 
coke roads, announce these; also tubes, not until you furnish staple 
articles can you get business among them sufficient to keep mines and 
furnaces in full operation. Never been time when more prompt action 
essential, indeed absolutely necessary to maintain property. Have no 
fear of result victory certain. 

On July 11 Andrew Carnegie wrote from Skibo in part as 
follows:' * 

Confirming my wire upon the situation, let me say that all is coming 
as expected. There is nothing surprising; a struggle is inevitable and 
it is a question of the survival of the fittest. For many years we have 
seen that the manufacturer must sell finished articles. One who 
attempts to stop half way will be crowded out. Briefly, if I were 
Czar, I would make no dividends upon common stock, save all surplus 
and spend it for a hoop and cotton tie mill, for wire mills, for tube mills, 
for lines of boats upon the lakes, etc. 

Had this steel war continued and developed into a relentless 
struggle between these mammoth concerns, serious losses would 
have resulted. While no doubt a large part of the purpose which 
inspired the stoppage of hostilities and the getting together of 
these concerns, was to avert the financial losses which would 
result from the cut-throat competition in lower prices of the 
product, and also of steel stocks which were beginning to assume 
importance on the stock market, there would have followed tre- 
mendous losses from the standpoint of production, from over- 
duplication of properties. As the commissioner of corporations 
points out in his report in 1911 on the steel industry: 

The active integration movement furthermore presented another 
very serious consideration. The extensions made by the crude steel- 
makers into the territory of those manufacturing more finished products 
and vice versa, meant not only increased competition but also a sudden 

^United States of America and U. S. Steel Corp. Statement of case, 
page 59. 



LARGE-SCALE ORGANIZATION 103 

and great increase in the productive capacity for crude steel and steel 
products, an increase that might place production, for some time at 
least, far beyond the country's power of consumption. 

Next to the desire to avoid the losses due to destructive com- 
petition, is the desire for the gains which come from the con- 
trol of prices through combination. Under competition where 
no regulation of the supply is possible there will be fluctuation 
and falling of prices. This was the condition in the steel busi- 
ness in the nineties; prices fluctuated violently, in spite of the 
efforts of the steel men to regulate them by means of pools and 
agreements. The dissolution of the Rail Pool in the early 
part of 1897, owing to the quarrel between Carnegie and the 
Illinois Steel Company, brought the price of rails tumbling 
from $28 on a ton, the average for 1896, to $16.47 and even 
to $14. Following this the prices of all classes of steel went 
down below cost. Since the organization of the United States 
Steel Corporation prices have been much more stable in the 
steel business. 

Another potent cause of combination is desire for the profits 
due to stock inflation that occur in the reorganization of com- 
bined companies. The large fortunes made by promoters and 
capitalists almost overnight, out of these combinations has no 
doubt been a pregnant cause of their coming into being. In 
the organization of the American Steel and Wire Company of 
Illinois in March, 1898, each $100 of the stock of the Consoli- 
dated Steel and Wire Company, one of the constituent concerns 
(and itself a consolidation of seven plants) received $175 of 
preferred stock and $175 of common stock of the new com- 
pany, or $350 of new securities for every $100 of old. $11,600,- 
000 of the common stock of the American Steel and Wire Com- 
pany went to its promoters and underwriters. Similar profits 
were made on the organization of the other constituent com- 
panies of the Steel Corporation while in the case of the United 
States Steel Corporation itself, they were stupendous. Some 
idea is gained by the enormous profit made by the Underwrit- 
ing Syndicate which in return for a cash expenditure of $28,- 
000,000 plus its promotion services, received steel stock of an 
aggregate par value of $130,000,000. 



104 PRACTICAL ECONOMICS 

These three causes, — restriction of competition, control of 
prices through combination and reorganization profits — are all 
causes influencing the formation of large compound corporations, 
and by the skeptical may be considered the only ones. There 
are, however, certain very real economies in production gained 
by large scale organization which we will treat in the following 
chapter. 

TEST QUESTIONS 

1. What is the difference between a holding company and a merger? 

2. What is meant by vertical combination? By horizontal combination? 

3. Outline the events in the steel industry leading up to the formation 
of the United States Steel Corporation. 

4. State ]the four chief causes of combination. 

5. In what industries have the tendencies toward combination been 
most marked during the last ten years? 

6. What industries will be likely to pass through these stages of com- 
bination in the next ten years? 



CHAPTER X 

THE ECONOMIES OF LARGE-SCALE 
ORGANIZATION 

GENERAL STATEMENT AS TO ECONOMIES 

By a large number of people the economies of large-scale or- 
ganization are regarded as mere pretexts invented by big busi- 
ness to camouflage its real motives, namely the largest possible 
profits. And there is without doubt basis for this opinion. 
There have been many cases of large combinations formed 
primarily for promotion profits and a monopolistic control of 
price, in the prospectuses of which the economies of combina- 
tion have played the part of decoy ducks to lure the general in- 
vestor, and to attract the attention of the public away from the 
real facts. A careful study of monopoly prices during the last 
twenty-seven years shows that the large profits gained in many 
cases are not fully accounted for by higher prices. In many in- 
stances the price has been increased but little, and in some cases 
not at all, as with steel up to the time of the war, and yet despite 
this fact, huge profits have been made, sufficient to pay divi- 
dends on millions of watered stock and put other millions (about 
450, in the case of the United States Steel Corporation) out of 
earnings into improved plant and equipment. Now if these ex- 
travagant profits have been secured with, or without, but a 
small increase in price, they must have issued largely from 
the economies of combination. Largely increased profits with, 
we will say, a slight increase in price, strongly point to the 
existence of some bona fide advantages in large-scale organiza- 
tion. There seems scarcely a doubt but that costs have been 
lowered; the wonder is that prices have not been reduced in 
some measure also. A study of the nature of these organizations 
would lead us to the conclusion that in many respects they 

105 



106 PRACTICAL ECONOMICS 

possess advantages over small competing concerns and this con- 
clusion is well reinforced by the experience of practical men 
connected with their operation. These advantages will, of course, 
apply differently in different industries, and their extent will 
vary according to the nature of the industry. 

PURCHASING 

In the buying of materials and supplies the large concern 
usually has an advantage over the small by buying in larger 
quantities at a lower price. This is well illustrated in the re- 
tail field by such organizations as the large five and ten cent 
stores, the chain stores and the large mail order houses, which 
owe a good measure of their success to their superior purchas- 
ing abilities. 

Not only is there a saving by buying in large quantities at 
a lower price, but by concentrating the buying in one depart- 
ment, under one head buyer, greater efficiency is obtained than 
when each concern had its own separate purchasing department. 
Mr. Pope, vice-president of the American Bicycle Company, 
in his affidavit to the Industrial Commission stated, that as a 
result of consolidation, "buying is concentrated in the hands 
of one officer and his assistants and this saves energy and ex- 
pense; a smaller aggregate quantity of supplies was carried 
than before and thus interest, insurance, storage and shop 
charges had been reduced." 

EXPENSIVE AND HIGHLY SPECIALIZED MACHINERY 

Many a small concern is handicappea owing to its inability 
to obtain or use the most efficient machinery in its line. This 
is not necessarily due to lack of capital, but oftentimes to in- 
sufficient output. Machinery and large-scale production have 
grown up side by side and the one is necessary to the other. 
Specialized machinery is only possible with quantity production. 
It would be an utter impossibility for an automobile plant turn- 
ing out but a few cars yearly to develop the highly specialized 
machinery for which the Ford plant is particularly famous. 

Perhaps the most striking example of an industry whose 
marvelous growth has sprung from the development of huge and 



ECONOMIES OF LARGE-SCALE ORGANIZATION 107 

highly specialized machines, is the steel industry. But this 
growth would have been impossible without the development 
also of huge organizations capable of purchasing and utilizing 
this machinery. 

MORE EFFICIENT USE OF PLANT AND EQUIPMENT 

A common occurrence, following the consolidation of a num- 
ber of competing plants into one centralized organization, has 
been the closing down of the weaker, and the concentration of 
production in the more efficient. In the case of the whisky trust, 
to cite a rather trite example, out of the 81 plants acquired all 
were shut down but 10 or 12. In the period of competition pre- 
ceding this consolidation more plants had sprung up than were 
necessary to fill the demand. By concentrating production in 
the most efficient plants and running those on full time, costs 
were cut way down. John W. Gates when asked why, after the 
organization of the American Steel and Wire Company, they had 
closed some of the plants said, "We have closed all of the plants 
that could not operate economically and increased those that 
could." When questioned as to the defects of the closed plants 
he stated that "Sometimes it was one of location and sometimes 
it was badly constructed machinery and sometimes it was a 
combination of both." Mr. Havemeyer also stated in evidence 
before the Industrial Commission: 

that the greatest advantage of the sugar combination is in working the 
refinery full and uninterruptedly. By buying up all the refineries, 
burning them up and concentrating the melting in four refineries and 
working them full, you work at a minimum cost. 

It should be noted here that the ability of the combination 
to make this saving is due to the condition of over-production 
and duplication of plants which has arisen under the preceding 
period of competition and that this saving is effected in two 
ways: first, by utilizing the most efficient plants; second, by 
running those plants at full capacity. 

PLANT SPECIALIZATION 

A further advantage arising out of a centralized control of 
plants lies in the ability of the management to extend the prin- 



108 PRACTICAL ECONOMICS 

ciple of specialization to individual plants. Instead of each 
plant manufacturing several different sizes or varieties of prod- 
ucts, by limiting it to one or two standard articles for which it 
is especially adapted, the costs of production may be materially 
cut. As that practical steel man, Charles Schwab, once said: 

You can get a greater output and a cheaper output from a mill by 
running that mill continually on one product. If we have two mills 
each of which is run on a specific product, one can be run on one, and 
the other on the other product, and thus get out a greater tonnage and 
do it at a much less cost. 

STANDARDIZING THE BEST METHODS OF 
MANUFACTURE 

One undoubted superiority of the combination over discon- 
nected competing plants, lies in the opportunity it affords for 
the exchange of information and the selection of the best pro- 
cesses of procedure followed by any of the plants and their 
adoption in all. Judge Gary in testifying to the economies 
achieved by the organization of the Federal Steel Company, said 
some years ago: 

I do not care what plant one goes into there are beneficial features 
in that plant that are not in other plants. In talking with any expert, 
information is received that will be beneficial if given to an official 
perhaps very remotely located, and of course the effort is to utilize 
to the best advantage everything that is a benefit in any particular 
plant. 

In the last few years tremendous savings have been made by 
the United States Steel Corporation through its whole hearted 
adoption of this policy. Mr. Lapham, vice-president of the 
United States Leather Company, also testifies to the advantages 
of this prmciple in the leather combine by stating that, "the 
chief saving effected by the consolidation has been the intro- 
duction of the best methods in all of the tanneries." This ex- 
change of ideas, practices, and knowledge made possible by co- 
operation and combination is of incalculable benefit to any in- 
dustry. To a limited extent it is possible under cooperative 
competition, but its benefits are more fully realized when pro- 
duction is controlled by one centralized organization. 



ECONOMIES OF LARGE-SCALE ORGANIZATION 109 

INTEGRATION 

Still further economies are gained when the combination is 
not merely lateral but vertical, linking up under a unified control 
the consecutive stages in the production of one commodity. 

In the first place there is a nicer adjustment of demand and 
supply between these various stages of production. The pro- 
ducers of the raw material depend for their demand on the 
manufacturers who in turn rely on the raw material men for 
their supply. It often occurs when these stages are carried on 
by separate interests, that the manufacturers are unable to 
secure a sufficient supply of the proper quality at the time they 
need it, and as often those in the raw material end find them- 
selves with an over-supply on hand. If then these interdependent 
concerns operating at different stages along the channel of 
production are directed by a central intelligence equipped with 
accurate information of the requirements of each, much of the 
loss through delays will be prevented and the stream of produc- 
tion will flow more evenly along its course. 

Not only does integration make possible a better regulation 
of inter-productional demand and supply, but secures great econo- 
mies in manufacturing by permitting a correlation of processes, 
which if carried on separately, would result in waste. In the 
steel industry this is particularly evident. Should the blast fur- 
naces be run independently of the bessemers and open-hearths, 
and these in turn be run separately from the rolling mills, in- 
conceivable wastes would follow. The contrast presented by the 
picture of Mr. Roberts of the disjointed methods of steel mak- 
ing in the seventies, with the smooth running continuity of pro- 
duction in a modern steel plant, makes clear to the veriest lay- 
man the tremendous savings secured through placing under 
a central control all of the processes of steel making. 

DIVISION OF LABOR 

Large-scale organization, whether in the form of a single large 
plant or a combination of plants, permits a greater degree of 
division of labor. We have already discussed the advantages of 
this principle and its dependence on large scale production. It 



110 PRACTICAL ECONOMICS 

will suffice to call attention to one aspect of labor specialization, 
that has been brought to the front during recent years by our 
large industrial combinations, namely, the advantages derived 
by its application to the higher orders of ability. This is brought 
out in a very practical way by a statement of Mr. Schwab in 
reference to the advantages of the United States Steel Corpo- 
ration. 

The steel making industry is, says Mr. Schwab, peculiar in this, that 
no matter how small the operations are there are certain skilled men 
in each lines necessary. If a firm has two furnaces or fifty-two, they 
can't do without our skilled man in each of their lines, as a skilled 
melter, skilled superintendent, skilled chemist, skilled draftsman and 
so on down the line. Now we can consolidate all these industries, we 
can have one selling man for example, one chief chemist, one chief 
engineer, that will answer all purposes, for all these works, by adopting 
the same methods at each of their works. 

In short, large-scale organization permits a more profitable 
employment of high priced and highly specialized men, pre- 
cisely as it does in the case of machinery. 

COMPARATIVE COST ACCOUNTING 

It is often urged against the large combination that it loses 
the stimulus that comes from competition; that it lacks the in- 
centive to cut costs or improve processes. But judging by the 
experience of some of the large combinations this does not 
seem to be an inherent lack of large-scale organization. In fact 
it has been found possible in some cases by standardizing sys- 
tems of accounting to inject an even keener kind of competi- 
tion into the operating plants and reduce costs below their level 
under previous competition. The old Carnegie Company was 
the pioneer in this practice; and the Steel Corporation through 
its monthly comparative cost statements prepared by its statisti- 
cal bureaus, copies of which are sent to the operating heads of 
each company, has been eminently successful in increasing out- 
put and cutting costs. To cite one instance from the experience 
of this corporation; as a result of sending to each blast furnace 
manager once a month the costs of each of the various blast 
furnaces, putting the most economical at the top and the least 



ECONOMIES OF LARGE-SCALE ORGANIZATION HI 

at the bottom, with the name of the manager and the condi- 
tions, they obtained a saving in the first year of approximately 
$4,000,000 in that department alone. Not only has it been fomid 
possible by means of comparative costs to fan the flame of com- 
petition and pit department against department and plant against 
plant, but also to locate the causes of inefficiency of the high 
cost plants and raise them to the level of the more efficient. 
By this means large-scale organization retains the benefits of 
competition and in addition secures the advantage of con- 
structive cooperation. 

SALES EFFICIENCY 

It is often said that production within the plant has been 
pretty well systematized but that the place for improvement 
is in getting the product from the plant to the consumer; here 
is where the waste lies. There seems little room for doubt 
but that the cost of selling many commodities is outrageously 
high and that if the price of commodities is to be lowered to 
the consumer the point of attack should be the distributing end 
of production. Here, again, large-scale organization seems to 
offer some help. 

A common occurrence following the formation of combines 
has been the disposal of many of the salesmen. The Whisky 
Trust were able to get along with 300 less; the American Steel 
and Wire Company dispensed with 200, and so on. Here 
the salesman, instead of the mechanic, is a victim of a labor- 
saving device, not this time an invention of iron or steel, but 
an improvement in the machinery of organization. Where be- 
fore five concerns each sent a man over the same territory, 
now one is able to handle the business at almost a fifth of the 
expense. There is, of course, a limit to the number of sales- 
men it is wise to dispose of. But the chief saving is not by any 
means in the reduction of salesmen; when a number of com- 
peting companies, each of which previously maintained a sepa- 
rate sales office and organization, unite and form one centralized 
sales office under the direction of a picked sales manager, the 
cost in officers' salaries, rents, clerical hire and so on, is much 
reduced, and the selling activities better directed and coordinated 



112 PRACTICAL ECONOMICS 

with production. There are cases where it is not wise to dis- 
pose of local officers but even so considerable cooperation is 
feasible, and overlapping of territory avoided. 

The large combination also possesses advantages in selling 
in foreign markets. The Standard Oil Company of New Jer- 
sey, The International Harvester Company, The Steel Corpora- 
tion and others have succeeded in securing a worldwide distribu- 
tion of products such as would have been beyond the power 
of small concerns. The Webb bill permitting combinations of 
competitors in foreign trade is a recognition of this fact. 

In the matter of advertising, the combination seems to possess 
some advantage. When a number of competing concerns are 
united, the waste due to competitive advertising can be elimi- 
nated. The number of brands may be reduced by standardiza- 
tion. Instead of each concern carrying on its own advertising, 
the whole of it may be concentrated under one control and a 
better distribution of the advertising obtained at a lower unit 
cost. Some saving no doubt is obtained by advertising a num- 
ber of related products under one brand, as the Armour people 
with their oval label and the Dupont Company, the National 
Biscuit Company and numerous others, which each have a whole 
family of products advertised under the family name* 

DELIVERY 

Most of the big combinations claim considerable savings in 
the cost of delivery of their finished products by the elimination 
of cross freights. The orders received by the combination are 
distributed to the most conveniently located plants; so that the 
consumer in the Chicago district receives his goods from the 
Chicago plant while the orders from the East are filled from the 
Philadelphia plant, thus making a considerable saving in freight 
charges over what would be necessary were the plants under 
separate management. Not only is the large national organiza- 
tion, by its geographical distribution of plants able to deliver 
more directly to the consumer, but the same savings are open 
to local industries. In the retail field there is a great opportu- 
nity for the reduction of delivery costs. Six laundry or grocery 
wagons go up one street where perhaps two could do the work. 



ECONOMIES OF LARGE-SCALE ORGANIZATION 113 

It would, of course, be a gigantic task to eliminate the waste 
efforts of competitive deliveries of grocers, bakers, etc., in any 
big city, but a large retail combination should be able to deliver 
at a lower cost than if each of the stores maintained its own 
delivery system. 

BY-PRODUCTS AND RESEARCH 

One of the most interesting features of industrial progress of 
recent years has been the remarkable manner in which industry 
with the magic wand of science has changed its wastes into 
useful products. Slag heaps have been transformed into con- 
crete bridges and buildings; out of the offal of the slaughter 
house have come all sorts of things from violin strings to rare 
medicines; even the smoke from the furnace has been arrested 
in mid-air and made to yield dyes, perfumes and powerful ex- 
plosives. Millions have been saved which were before lost. The 
United States Steel Corporation is saving between 1,700,000 
and 1,800,000 tons of coal a year by the use of blast furnace 
gases and gas from coke ovens, and is manufacturing annually 
from blast furnaces slag previously wasted, over ten and a 
half million tons of cement. It should be borne in mind that 
this by-product development is itself a by-product of large-scale 
production. The large plant makes possible a utilization of ma- 
terials that in a small concern would be wasted. 

Closely related with by-product saving is the experimental and 
research work carried on by the big organizations. The object 
is to improve the product or service to the consumer, to find 
new uses for the commodity, or more economical methods of 
manufacture. These research departments are often conducted 
along broad lines and are by no means entirely commercialized. 
Scientists of various descriptions, chemists, physicists, engineers, 
are employed and allowed to "carry on" pretty much as they 
please, indulging in many cases in almost pure scientific re- 
search. Experimental research of this nature is beyond the 
reach of the small concern and seems further to discount the 
argument that big business lacks the spur to progress furnished 
by competition. A trip through the laboratories of some of 
the large organizations, such as the Eastman Kodak Company, 



114 PRACTICAL ECONOMICS 

the Edison Company, the General Electric Company, The Curtis 
Publishing Company, The American Telephone and Telegraph 
Company and numerous others, and especially a chat with their 
occupants, would be an enlightenment to those who believe that 
large-scale organization by its very nature puts a damper on 
the fires of progress. 

ECONOMY IN MANAGEMENT 

Finally, in the field of management itself the combination 
possesses advantages. Under competition each concern had its 
own president and officers, after combination it has been found 
feasible to reduce the number of these expensive individuals 
and yet run the concerns efficiently. The American Steel and 
Wire Company at its organization dispensed with fifty per cent 
of the high priced executives of the constituent plants by putting 
the operating end of the business in charge of officers in New 
York and Chicago. There is of course a limit to this economy as 
to all others, but as a general principle, a more effective employ- 
ment of managerial ability and a saving in the cost of manage- 
ment results from a centralization of organization. 

CONCLUSION 

The above list by no means exhausts the economies of large- 
scale organization, but presents a brief discussion of the major 
ones. It should be noted that these include not merely the ad- 
vantages due to quantity production or size of plant, such as 
are sometimes referred to under the term "large-scale pro- 
duction," but take in those economies which proceed from the 
modern development in the field or organization we have termed 
"large-scale organization." The advantage of the big combina- 
tion or the large compound corporation over a number of 
separate competing concerns, lies in the fact that it furnishes a 
form of organization permitting a fuller expression of the prin- 
ciples of organization. It secures a greater degree of centraliza- 
tion of control, of specialization, of unity of purpose. 

During the last few years large-scale organization has been 
rightly scrutinized and criticized. The radical element in the 
nation, however, has at times jumped to the conclusion that be- 



ECONOMIES OF LARGE-SCALE ORGANIZATION 115 

cause some combinations have been guilty of mispractices, all 
are bad and should be destroyed ; and much legislation has acted 
on this principle. An impartial analysis of their advantages 
simply as producers is, therefore, not out of place. If many of 
the commodities consumed by the public can be produced 
through these organizations more cheaply than ever before, if 
they increase the production capacity of the nation and render 
it more efficient in international competition, to destroy them 
would be short-sighted, especially if some effective regulation of 
them in the public interest can be secured. 

TEST QUESTIONS 

1. Name twelve economics of large-scale organization. 

2. What is the distinction between "large-scale production" and "large- 
scale organization"? 

3. What advantages has a combination over a number of separate com- 
peting companies in the matter of sales efficiency? 

4. How has large-scale organization encouraged the utilization of by- 
products? 

5. How can competition be secured within a large combination? 

6. Do facts justify the statement that "trusts" tend to arrest the im- 
provement of the products they control? 

REFERENCES 

Bloomfield, M., Management and Men. 

BuRGLAND, A., The United States Steel Corporation, Ibid., XXVII (1907). 

Carver, T. N., Principles of Political Economy. 

Clay, H., Economics for the General Reader (Chaps. III-VIII). 

DuRAND, E. D., The Trust Problem. 

Edie, L. D., Principles of the New Economics (Chap. VIII). 

Ely, R. T., Outlines of Economics (Chap. XIII). 

GiDE, C, Political Economy (Part II, Chap. 1). 

Haney, L. H., Business Organization and Combination. 

Jenks, J. W., The Trust Problem. 

Jones, E., The Trust Problem of the United States. 

Kimball, D. S., Principles of Industrial Organization. 

MacGregor, D. H., Industrial Combinations. 

Macrosty, H. W., The Trust Movement in British Industry. 

Marshall, A., Industry and Trade; Principles of Economics (Book IV, 

Chaps. VIII-XII) . 
Marshall and Lyon, Our Economic Organization. 
Moody, J., The Truth about the Trusts. 



116 PRACTICAL ECONOMICS 

Montague, G. H., The Rise and Fall of the Standard Oil Company ._ 

Nicholson, J. S., PoHtical Economy (Chap. VIII). 

Ripley, W. Z. (Ed.), Trusts, Pools and Corporations. 

Stevens, W. S., Industrial Combinations and Trusts. 

Tarbell, Ida, History of the Standard Oil Company. 

Taussig, F. W., Principles of Economics (Chap. 63). 

Van Hise, C. R., Concentration and Control. 

Wilson, W., The New Freedom. 

Bureau of Corporations Reports on the Beef, Petroleum, Tobacco, and 

Steel Industries. 
United States Industrial Commission Report, I, II, XVIII, XIX. 



CHAPTER XI 

ORIGIN AND NATURE OF VALUE 

DIVISION OF LABOR RESULTS IN EXCHANGE, AND OUT 
OF EXCHANGE SPRINGS VALUE 

In any system of industry based on private enterprise ex- 
change is the necessary sequence of division of labor. It is 
evident that if each individual is to devote himself to the pro- 
duction of one commodity there must follow an exchange of 
products. In a primitive community devoid of division of labor 
and exchange, there was no separation of individuals into pro- 
ducers or consumers. Immediately two individuals exchange 
their products the producer and the consumer appear as separate 
individuals, each party to the exchange is producer to the other, 
and each is consumer to the other. As each naturally wishes to 
make a favorable exchange, a division of interests occurs; the 
question comes up of the amount of one's product which one will 
exchange for a certain quantity of the other's, and thus the prob- 
lem of value appears. 

EXCHANGE, VALUE AND DISTRIBUTION 

In a primitive society where each individual was self-sufficient, 
producing only that which he consumed and consuming only that 
which he produced, there would be no labor troubles or industrial 
unrest. No one could feel he was not receiving a square deal or 
that he was not getting as much as he was worth ; each would be 
receiving exactly what he produced; the amount he consumed 
would depend directly on the amount he produced. Just as soon 
as exchange arises the producer ceases to produce directly what 
he consumes. The amount of commodities he enjoys as a con- 
sumer is determined by the amount of the products of others his 
own product will command in exchange, on the exchange value of 
his product. 

117 



118 PRACTICAL ECONOMICS 

If instead of bartering his product directly for the products 
of others, he sells them in the market, and with the money re- 
ceived buys consumption goods, the case remains the same except 
that he has exchanged his product for that of others through the 
medium of money. The amount of goods he will obtain as a 
consumer will depend on two exchanges, first on the sum of 
money he receives in exchange for his product, and second on the 
amount of commodities his money will exchange for on the 
market. 

With the development of division of labor and the extension 
of the market with all its intricate machinery for facilitating 
exchange, most products pass through the hands of several pro- 
ducers before reaching the consumer. If it be a production good 
as iron or steel it may never reach any so-called ultimate con- 
sumer, but will aid in the production of some consumption good 
or service. Even if it be a consumption good, such as shoes in 
the hands of a manufacturer, it will usually circulate through the 
wholesaler and retailer before it finds the consumer. This process 
of exchange is further complicated by the fact that one indi- 
vidual does not produce a whole product, but several cooperate 
through some form of business organization. Out of the money 
price for which the product is sold on the market, each receives a 
share in exchange for the part he has played in its production. 
The owners of land receive theirs in the form of rent, the owners 
of capital in interest, the workers in wages, and the owners of 
the organization in profits. These money shares they exchange 
in the market for commodities produced by others in a similar 
manner. In this case, instead of each exchanging his products 
he exchanges his services, and the amount of goods he will have 
at his disposal as a consumer will depend on the exchange value 
of the services he renders in production. 

In our present economic system we do not produce directly 
the commodities we consume, but secure them through a round- 
about process of exchange in return for the part we play in pro- 
duction. In reality the world is a market, and we are the buyers 
and sellers. We enter it first as sellers of our products or services 
and later as buyers of the things that make life worth while. 
The amount of money which we as buyers have to spend depends 



ORIGIN AND NATURE OF VALUE 119 

on the amount we as sellers have been able to obtain for our 
services or products. It is in the factory under the laws that 
govern efficiency that commodities are produced. But it is in the 
market under the laws that govern value, that they are distrib- 
uted. From the time we leave school till we totter toward the 
grave the great majority of us are selling either service or prod- 
ucts. On the value of these depends our share of the things that 
make life worth living. As buyers and as sellers we are equally 
interested in the forces that determine the values of things. No 
subject so closely affects our well-being. 

THE DIFFERENCE BETWEEN UTILITY AND VALUE 

In our discussion of production we were concerned with utility; 
the moment we introduce the subject of exchange we begin to 
speak of value. The problem of production is the creation of 
utilities in economic goods; that of exchange, we say, is the deter- 
mination of the value of those goods. First, let us distinguish 
clearly the difference between the terms "utility" and "value" 
as they are used in economics. Utility we have defined as the 
power a commodity possesses of satisfying a want. In general 
parlance, the word value is often used to express what in eco- 
nomics is termed utility. The economist says fresh air under 
ordinary conditions has no value. The man in the street answers 
back that of course air has a value, and the argument waxes hot. 
Now, as James would say, "You are both right and both wrong; 
it all depends on what you practically mean by the term value." 
If by value is meant want-satisfying power, fresh air certainly 
has value; if by value is meant the power to command other 
things in exchange, then fresh air under ordinary conditions 
has no value, for who in his right senses would pay anything 
for a cubic foot of air? In economics the term value is used 
to express the power which a good has to command other 
goods in exchange for itself. 

Utility and value, then, are two different powers. It is a fa- 
miliar fact that many things, as water in the lakes, sunshine and 
fine scenery, satisfy wants, yet have no power to command any- 
thing in return. They are free goods, possessing utility but no 
value. The various commodities and services which are the 



120 PRACTICAL ECONOMICS 

objects of business transactions not only satisfy wants but 
possess the power of exacting a payment for this satisfaction. 
In addition to mere utility they possess value, the power of com- 
manding other things in exchange for themselves. 

UTILITY AN ELEMENT OF VALUE 

Though utility and value are different they are intimately 
related. Free goods possess utility, but not value; all goods, 
however, having value possess utility. It is evident no one will 
give anything for something he does not want. Utility, then, is 
of necessity an ever-present element of value. Is there any other 
universal element in value? As both free and economic goods 
have utility, to what do economic goods owe their value? 

HOW VALUE ORIGINATES 

For the sake of illustration, let us suppose some outdoor loving 
American, lured perhaps by aggressive Canadian advertising, is 
spending his vacation canoeing on one of Ontario's wild and 
beautiful lakes. Since it is a hot summer day, he is thirsty, and 
so dips his cup in the lake or better still, in camping vernacular, 
''shoots the bottle"; that is, he lowers a stoppered bottle weighted 
with a stone to the bottom of the lake, jerks out the stopper and 
draws up a bottle of cool water to quench his thirst. Let us 
suppose, again, a traveler on the Sahara Desert with only a 
meager supply of water left in his canteen, which he has been 
hoarding with jealous care, arrives at an oasis owned by an 
Arab sheik and bargains for a supply of fresh water. In both 
cases the commodity quenches thirst and has utility; in the 
second case it possesses also value. What is the cause of the 
value of the water in the second case? The illustrations sug- 
gest the answer: scarcity. Though scarcity is often obscured 
by other causes more apparent, it is a fundamental cause of 
values everywhere, and it is worth our while to see just how it 
gives rise to value. 

Let us notice why water under the conditions of supply given 
in the first case has no value. No matter how thirsty is our 
canoeist, there is more water in the lake than he can drink. So 
that if a cupful is taken away no want will go unsatisfied owing 
to its removal. Nor if a cup is added to his supply will any 



ORIGIN AND NATURE OF VALUE 121 

want be satisfied which otherwise would have remained unsatis- 
fied. None of his wants depend on any unit of the supply for 
their satisfaction, and no unit is essential to the satisfaction of 
any of his wants. Therefore, if a cup is added he gains nothing 
and if a cup is taken he loses nothing. As long as he has more 
water than he wants a cup more or less is a matter of complete 
indifference to him. And although if he is thirsty he will drink 
it with as much gusto as the finest champagne, he would pay not 
a cent for it. 

On the Sahara the conditions are reversed, the traveler instead 
of having more than he wants, wants more than he has. If he 
should spill a cup on the desert sand a want will remain which 
otherwise would have been satisfied. A cup added to his supply 
means a want filled which without it would have to go unsatis- 
fied. A want now depends on each unit of his supply and each 
cupful possesses an importance as the means to the satisfaction 
of some want. If a cup is taken away he loses a satisfaction, if 
one is added he gains. Water thus becomes an object of economy; 
rather than suffer thirst he will be willing to pay for a cup of it. 

UTILITY AND SCARCITY 

Hence it follows that whenever the supply of a good is in 
excess of wants for it, units of that good will have no value and 
the good becomes free. Just as soon as the supply of a good is 
less than the wants for it, units of that good become objects of 
economy and possess value. Economic goods are thus defined 
as those goods the supply of which is less than the demand for 
them.. Value then is born of a union of utility and scarcity. 
Neither one of these alone gives rise to value, for however useful 
a commodity is, its supply must be limited to have value; and 
however scarce a commodity is, it must be wanted to possess 
value. In all values everywhere these two elements are always 
present. They are the two universal causes of the values of 
economic goods. 

THE RELATION OF LABOR TO VALUE 

While the exchange value of economic goods springs from a 
union of utility and scarcity, there are many other subordinate 
causes that help to determine values, all of which operate 



122 PRACTICAL ECONOMICS 

through these two fundamental ones, and sometimes obscure 
them. One of the most important of these is labor. So impor- 
tant is it, that it has been regarded by some as the sole element 
and determinant of value. This view has resulted in the famous 
labor theory of value, espoused by no lesser lights than Adam 
Smith, Ricardo, and especially by Karl Marx. Ricardo regarded 
labor "as being the foundation of all value and the relative 
quantity of labor as almost exclusively determining the relative 
value of commodities." Karl Marx states that "the value of a 
commodity is determined by the quantity of labor expended 
during its production." While we are yet not quite prepared to 
discuss what does determine the relative amounts of exchange 
values of ^ commodities, we will stop to notice that labor cannot 
be the sole determinant. 

Though the values of things in general may correspond roughly 
to the quantity of labor expended on them, such is by no means 
always or necessarily the case. In the first place, once a com- 
modity is made the amount of labor is fixed, but not so its price. 
A residence built in a neighborhood that for some reason becomes 
undesirable may in a few years sell for half its original value. 
A painting that during the lifetime of the artist fetched but a 
few dollars may after his death be worth hundreds. Even his 
autograph, dashed off by a few strokes of his pen, may then sell 
for more than his painting did while he was alive. Of a stock 
of straw hats, those that sell in June for $2.50 have had the same 
labor expended on them as those that are reduced to $1.25 in 
August. A change of fashion may leave a garment which cost 
much in labor almost valueless. On the other hand, many things 
have great value even though untouched by the hand of man. 
Coal in the seam, iron, copper, gold, possess value just as they 
lie in the earth. 

That labor is an important factor in determining values no 
one for one moment doubts. Where the labor theory championed 
by Marx errs is in setting up labor as the sole source and de- 
terminant of values. Commodities do not possess value because 
labor has been spent on them but because they satisfy wants, 
and their supply is limited in relation to those wants. It is 
true that most commodities owe their want satisfying power 



ORIGIN AND NATURE OF VALUE 123 

largely to labor which plays an important part in creating the 
utilities in economic goods and utility is one of the causes of 
value. Labor thus indirectly influences value through utility. 
Most commodities owe also their scarcity largely to the fact that 
labor must be spent on them and scarcity is the other cause of 
value. Labor then might be termed a secondary or indirect 
cause of value by virtue of it being a tributary cause of both 
utility and scarcity to whose union value owes its origin. 

VALUE AND PRICE 

We defined value as the power which a commodity possesses 
of commanding other things in exchange for itself. It is 
measured by the amounts of other commodities one product is 
able to command in exchange. Under a system of barter where 
things were exchanged directly for each other their values would 
be expressed and measured in amounts of each other. The value 
of a bushel of wheat would be measured by the amount of 
corn, cloth, leather or hats it would exchange for. To express 
the value of a number of articles in terms of every other would 
be a most awkward method of measuring and comparing values. 
With only one hundred products to exchange there would be re- 
quired no less than 4,950 separate valuations. Very early in 
most countries, owing to the awkwardness of barter, some one 
commodity came to be used as a medium of exchange and it 
became customary to express the values of all others, in terms 
of this one commodity, known as money. 

By expressing the values of all commodities in terms of money, 
it is possible to compare the values of a multitude of the most 
diverse things, such as a doctor's skill, a lawyer's advice, a suit 
of clothes, a shave, or a victrola. Money acts as a common 
denominator of values, a means of ascertaining at once the rel- 
ative value of any one of a number of entirely different things 
and in so doing tremendously facilitates the exchange of com- 
modities. It has thus become a standard of value by which the 
values of all things are judged. The value of a bushel of wheat 
or a day's labor is no longer measured directly by the amount 
of other commodities it might command in exchange, but by 
the sum of money it will bring in the market, which is termed 



124 PRACTICAL ECONOMICS 

its price. And the price of a commodity or service has come 
to be universally regarded as the measure of its exchange value. 

The fact that commodities are no longer exchanged directly 
for one another but indirectly through the medium of money, 
tends to make us forget that the ultimate object of every sale 
of a product or service is not the money it brings, but the com- 
modities for which that money will eventually be exchanged. 
A sale is but one-half of an exchange and the amount of com- 
modities that are finally obtained depends not only on the price 
received from the sale but also on the prices paid for the pur- 
chased goods. The money value of a clerk's services for a month 
may be $100, but their real value is measured by the amount of 
commodit^ies he is able to purchase with his salary. The clerk 
does not work for money itself but for a home and the other 
things it will buy. And though it is generally true that the 
amount of money the clerk receives is a measure of the amount 
of goods he will be able to command, it is well to recognize that 
the price of a commodity or service is not its real value but a 
measure of its value and a measure which though generally cor- 
rect is not always so. Just as the compass at different places 
does not accurately indicate true north, but a little east or west 
of it, so the money price of a commodity at different times may 
not accurately indicate its true value but may require a cor- 
rection. 

At any one time the price of a product or service is an accurate 
measure of the amounts of other commodities it commands in 
exchange. But prices change and a change in price of one com- 
modity does not always mean a corresponding change in its 
value. Suppose that at one date wheat is $1 a bushel, corn 
75 cents a bushel, hats of a certain grade $2, shoes $4 a pair. 
If at the end of a certain period the prices of all these articles 
have doubled, their relative values remain the same. The price 
of hats has doubled but so have the prices of other commodities, 
so that the value of hats in terms of wheat or corn is still the 
same. Though the farmer can sell his wheat at $2 instead of $1, 
he must pay double for his hats and shoes; he must still raise 
four bushels of wheat to purchase one hat. If the prices of all 
should fall to one-half their original amounts so that wheat sold 



ORIGIN AND NATURE OF VALUE 125 

for 50 cents and shoes at $2 a pair, their real values in terms 
of each other would still remain unchanged and the farmer's 
four bushels of wheat would be worth a pair of shoes as before. 

A change in the prices of all commodities means a change in 
the value of money. A general rise in prices means a correspond- 
ing fall in the value of money. If prices double and wheat which 
was sold at $1 a bushel now sells at $2 a bushel ; corn which 
before was 75 cents now sells at $1.50 a bushel; and $2 hats 
sell for $4, it is evident that a dollar will purchase now only 
half of these commodities that it would formerly, which is the 
same as saying that the value of a dollar has been cut in half. 
If there should be a general fall of prices to one half their 
original amount so that wheat sells for 50 cents instead of $1 
a bushel, and other commodities likewise, then a dollar will 
purchase two bushels of wheat where before it was worth only 
One; its purchasing power will be doubled which means that 
the value of money will be doubled. Thus prices and the value 
of money are usually said to vary inversely, whenever prices' 
go up the value of money goes down and vice versa. A like 
change in the prices of all commodities means a change in the 
value of money but leaves the value of any particular com- 
modity unchanged. A rise or fall in the price of a com- 
modity does not necessarily indicate a change in its true value, 
that is its value in relation to other commodities. 

On the other hand, the fact that the price of a commodity or 
service remains the same over a period of time does not neces- 
sarily indicate that its value is the same. For if in the meantime 
the prices of other commodities have risen its value in rela- 
tion to those commodities will have fallen. Suppose that at 
the entrance of the United States into the world war the salary 
of a clerk was $100 a month and that the prices of commodities 
have in the interim jumped 100 per cent. His $100 now pur- 
chases but half of the food, clothing and shelter it did before. 
The money value of his services may remain the same but their 
true value in amounts of those things that maintain existence, is 
cut in half. He may be granted a $50 raise and imagine he is 
forging ahead, when in reality he is still a quarter of a lap be- 
hind his old position. If, however, instead of rising, the prices 



126 PRACTICAL ECONOMICS 

of commodities should fall, and the wages of our clerk lag be- 
hind, his $100 would increase in value. 

The general level of prices or the value of money changes but 
slowly, but the individual prices of most commodities change 
quickly and constantly arid a change in one means a change in 
its relation to others; so that as a general rule a rise or fall in 
the price of a single commodity registers a rise or fall in its value 
and for most practical purposes price is the measure of value. 

Having surveyed the origin and nature of value and noticed 
the relation of price to value, we are ready to see how prices are 
determined and what forces actuate their rise and fall. 

TEST QUESTIONS 

1. How does a division of interests spring up in a system of exchange? 
' 2. Show the distinction between utihty and value and the relation 
between utility and value. 

3. How does scarcity affect value? 

4. What is the relation of labor to value? 

5. Explain why at two different periods a change in the price of an 
\article may not mean a change in its value. 

6- What is meant by the statement that the value of money and prices 
vary inversely? 

REFERENCES 

Bohm-Bawerk, E. von, Positive Theory of Capital (Book III, Chaps. 

I-IX). 
Cairnes, J. E., Character and Logical Method of Political Economy (Part 

I, Chap. I). 
Carey, M., Pohtical Economy (Chap. II). 
Clark, J. B., Philosophy of Wealth (Chap. V). 
Clay, H., Economics for the General Reader (Chap. XIV), 
Jevons, W. S., Theory of Pohtical Economy (Chap. III). 
Marshall, A., Principles of Economics (Book III). 
Say, J. B., Pohtical Economy (Book II, Chap. I). 
Smart, W., Introduction to the Theory of Value (Chap. II-VIII). 
Smith, A., Wealth of Nations (Book I, Chap. V). 
Pantaleoni, M., Pure Economics (Part I, Chap. I). 
Pierson, N. G., Principles (Part I, Chap. I). 

RiCARDO, D., Principles of Political Economy and Taxation (Chap. I). 
Walsh, C. M., Measurement of General Exchange Value (Chap. I). 
Wicksteed, p. H., The Common Sense of Pohtical Economy (Book I). 



CHAPTER XII 

THE LAW OF DEMAND AND SUPPLY 

STATEMENT OF THE LAW 

Ask the average business man what determines prices and he 
will promptly answer ''demand and supply." He expresses a 
truth hammered out of experience. It is a matter of universal 
observation that an increase or decrease in the supply of a com- 
modity tends to lower or raise its price, and similarly that any 
increase or decrease in the demand for a commodity tends to 
raise or lower its price. The market price of a commodity sold 
under competition is thus said to be governed by the law of 
demand and supply, which means that its price is determined 
by the relationship existing between the demand for it and the 
supply of it. 

THE MEANING OF DEMAND 

In order to see just how this famous law operates in de- 
termining prices, we must first obtain a clear understanding of 
the terms, "demand" and ''supply," which are not quite as simple 
as they seem. In fact considerable confusion has resulted 
through neglecting to define the exact meaning of both demand 
and supply as they are used in reference to the above law. 
Demand, for instance, does not mean plain desire nor the mere 
amount of a commodity that will be purchased irrespective of 
the price. There is no one such amount but several varying with 
the prices asked. At a low price a comparatively large quantity 
will be bought; a higher price will induce a lesser quantity and 
so on. Therefore at any one time on a particular market, the 
demand for a commodity will consist of a number of different 
amounts which buyers will purchase at different prices. The 
amount that will be bought will always depend on the price 
asked. To speak of the demand for a commodity in the sense 

127 



128 PRACTICAL ECONOMICS 

of the mere amount that will be purchased, without reference 
to any price is meaningless. It is impossible to estimate the 
amount that will be bought without knowing the price that is to 
be asked. Demand is a relationship between quantity and price. 
The demand for any commodity is expressed by stating the 
amount that will be purchased at a certain price, or the amounts 
that will be purchased at stated prices. 

DEMAND SCHEDULES 

On a local produce market at any given time it would be pos- 
sible for a produce man well acquainted with the market to 
figure out approximately the amounts buyers would purchase 
at different prices. Such schedules are sometimes made up on 
the grain exchanges. A table of the amounts buyers will pur- 
chase is called a demand schedule and is in reality an estimate 
of the demand for a commodity on a particular market at a 
given time. For the sake of illustration, let us suppose that on 
a particular produce market on a certain date buyers of apples 
will purchase the following amounts at the stated prices: 

At a price of $1.00 — 900 barrels will be bought. 

At a price of 1.25—800 barrels will be bought. 

At a price of 1.50 — 700 barrels will be bought. 

At a price of 1.75 — 500 barrels will be bought. 

At a price of 2.00 — 300 barrels will be bought. 

At a price of 2.25 — 100 barrels will be bought. 

AN INCREASE OF DEMAND 

Now let us assume that the following season the demand for 
apples on this particular market has increased; apples perhaps 
have been extensively advertised, business conditions have been 
good, so that buyers will now purchase the following amounts: 

At a price of $1.00 — 1000 barrels will be bought. 

At a price of 1.25 — 900 barrels will be bought. 

At a price of 1.50 — 800 barrels will be bought. 

At a price of 1.75 — 700 barrels will be bought. 

At a price of 2.00 — 600 barrels will be bought. 

At a price of 2.25 — 500 barrels will be bought. 

This second schedule illustrates what is mean by an increase in 



THE LAW OF DEMAND AND SUPPLY 129 

demand. Larger amounts will be bought at the same prices 
than before. At a price of $1.75 buyers will now purchase 700, 
instead of 500 barrels. 

THE LAW OF DEMAND 

At any one time, without any change taking place in the condi- 
tions of demand, a larger amount will be bought at a lower price. 
As the first schedule indicates at a price of $1.75, 500 barrels will 
be bought, while at $1.50 buyers will take 700 barrels. The 
terms expansion and contraction describe better the increase or 
decrease in the amounts that will be purchased at lower or 
higher prices, under the same condition of demand. The fact 
that a larger amount will be purchased at a lower price does not 
signify an increase of demand in the true sense of the term; it 
simply illustrates a universal law, the law of demand which 
states that the amount of any commodity buyers will purchase 
varies inversely with the price. The higher the price the smaller 
the amount that will be purchased, the lower the price the larger 
the amount. 

ELASTICITY OF DEMAND 

If these amounts vary greatly with price changes, the demand 
is said to be elastic; if they vary but little it is said to be in- 
elastic. A commodity is said to have an elastic demand when 
a small change in its price results in a great change in the quan- 
tity that buyers will purchase. The amount of such a commodity 
that will be bought will expand readily in response to a fall in 
price, and contract readily in response to a rise in prices. Most 
luxuries or near-luxuries or articles which have available sub- 
stitutes possess an elastic demand. If prices for such articles 
go up people restrict their purchase; if they go down they buy 
more and others buy who before could not afford them. On the 
other hand, if the amount of a commodity that will be bought is 
not much affected by price changes, the demand for it is said 
to be inelastic. Most necessaries are of this type: salt, matches 
and bread, for instance. A rise or fall in the price of salt will 
not greatly affect the amount consumed ; demand for it is there- 
fore said to be inelastic. 



130 PRACTICAL ECONOMICS 

SUPPLY SCHEDULES 

In a similar manner the amounts which sellers are willing to 
offer for sale will vary with the prices that can be obtained. A 
schedule of the amounts of a commodity that will be offered for 
sale on a particular market at a given time is called a supply 
schedule. Such a schedule is an estimate of the conditions of 
supply for a commodity and illustrates what is meant by the 
term supply. We will suppose that on the same produce market, 
at the same time, covered by the first demand schedule, sellers 
are willing to offer the following amounts at the prices stated 
below: 

At a price of $1.00—200 barrels will be offered. 

' At a price of 1.25 — 300 barrels will be offered. 

At a price of 1.50 — 400 barrels will be offered. 

At a price of 1.75 — 500 barrels will be offered. 

At a price of 2.00 — 600 barrels will be offered. 

At a price of 2.25 — 700 barrels will be offered. 

AN INCREASE IN SUPPLY 

We will assume that on the following season apples are more 
plentiful, owing to an abundant crop or to a decrease in the 
production costs or transportation charges, so that on the same 
market sellers are willing to dispose of the following amounts: 

At a price of $1.00— 400 will be offered. 
At a price of 1.25 — 600 will be offered. 
At a price of 1.50 — 800 will be offered. 
At a price of 1.75 — 1000 will be offered. 
At a price of 2.00—1200 will be offered. 
At a price of 2.25—1400 will be offered. 

This second schedule illustrates an increase of supply. The 
conditions of supply have changed so that now larger amounts 
are offered at the same prices. 

THE OPERATION OF DEMAND AND SUPPLY IN COMPETI- 
TIVE MARKET ILLUSTRATED 

The next question is: How are prices determined by demand 
and supply in competitive buying and selling? In order to 
illustrate their mode of operation, we will take the two schedules 



THE LAW OF DEMAND AND SUPPLY 131 

of apples, which represent the conditions of demand and supply 
for apples on a produce market at a given time: 



Demand 






Supply 


At a price of $1.00- 


-900 bought. 


Price of 


$1.00—200 offered. 


At a price of 1.25- 


-800 bought. 


Price of 


1.25—300 offered. 


At a price of 1.50- 


-700 bought. 


Price of 


1.50—400 offered. 


At a price of 1.75- 


-500 bought. 


Price of 


l.fS- 500 te©«g;ht. 


At a price of 2.00- 


-300 bought. 


Price of 


2.00—600 bcraght. 


At a price of 2.25- 


-100 bought. 


Price of 


2.25—700 offered. 



'MC^ 



Under the conditions of demand and supply given above, 
would $1.00 be likely to become the market price for apples? 
At that price, as the schedule shows, buyers are anxious to secure 
900 barrels, but sellers are only willing to offer 200 for sale. 
The shortage would soon become apparent and there would be 
a rush of buyers, many of whom, rather than be disappointed, 
would offer higher prices, with the result that competitive bid- 
ding would force the price up. At a price of $1.50 the schedule 
indicates that there will still be a scarcity of apples for sale, in 
proportion to the demand for them, and sellers will not hesitate 
to take advantage of the competition among buyers and will 
boost the price. Should it rise to $2.00, sellers who up to this 
time have been holding back will put their supplies on the mar- 
ket until, as the schedule indicates, there will be 600 barrels 
offered for sale. The heightened price will also cause buyers to 
reduce their purchases and many of the poorer ones to drop out, 
so that the demand shrinks to 300 barrels. If the price were to 
be maintained at $2.00, only half of the supply would be dis- 
posed of. Competition among sellers, who do not wish to be left 
with a supply on their hands, will lower the price. At $1.75 a 
barrel, the schedules indicate sellers are willing to sell and buyers 
to purchase the same amounts, namely, 500 barrels. This price 
would "clear the market" and satisfy all concerned. And this 
is the price that demand and supply with the aid of competition 
tend to establish. This is the natural market price, the natural 
price in that it is the price which demand and supply, when 
perfectly free from combination and monopoly, tend to establish 
by competition. It is at bottom a psychological operation 
brought about by competing buyers and sellers, each seeking his 
own gain in a perfectly natural manner. 



132 PRACTICAL ECONOMICS 

THE EQUILIBRIUM PRICE AND THE EQUATION OF 
DEMAND AND SUPPLY 

The price that demand and supply tend to establish is some- 
times called the equilibrium price; a good name in that it sug- 
gests the real nature of this whole process of price determination, 
which is in reality a balancing of two opposite forces. The price 
which is finally -fixed or to which all other prices are constantly 
tending is said to be the equilibrium price, on account of its being 
that one price which under the given conditions equalize demand 
and supply. In the two schedules above, $1.75 is the one price 
which equalizes the amounts which sellers wish to sell and buyers 
to buy. The fact that competitive prices are ever tending toward 
that onev price which equalizes demand and supply has led 
economists to state that prices are determined by the equation 
of demand and supply. It is as if two blind forces were forever 
groping for the price that will establish their equilibrium and 
set them at rest. 

DEMAND AND SUPPLY CHARTED 

The interaction of demand and supply is often illustrated by a 
diagram on which the schedules are represented by curves. In 
Fig. 2 distances along the line ox measure amounts of commodi- 
ties; in this case the unit amount is 100 barrels of apples, and 
distances up the vertical line O Y denote prices. The curve SS 
is the supply schedule charted, indicating the amounts sellers 
will supply at the stated prices: at a price of $1.00 the curve 
shows that 200 barrels will be supplied, and so on; this curve 
ascends to the right, indicating the increase in the amount of 
the supply as the price goes up. In a similar manner the demand 
schedule is represented by the curve DD, which registers the 
amounts purchasers will buy at the stated prices, and ascends 
to the left in accordance with the universal fact that the amount 
demanded decreases with the increase in price. 

HOW THE EQUILIBRIUM PRICE IS DETERMINED BY 
THE EQUATION OF DEMAND AND SUPPLY 

This diagram serves as a map of a market for a commodity 
at a given time and charts the two great market forces, demand 



THE LAW OF DEMAND AND SUPPLY 



133 



and supply. It pictures the equilibrium price which, when de- 
mand and supply are charted in this manner, will always be at 
the intersection of the two curves. At a price of $1.50 the supply 
curve registers a supply of 400 barrels, while the demand curve 
shows buyers anxious to purchase 700. At this price the demand 
is heavier than supply and will force the price upwards by com- 
petitive bidding. It might rise to $2.00, but at this price level 
the curves indicate a demand for 300 barrels and a supply of 
700. Buyers will hang back, while competition among sellers 



y 








































$2.25 
$2.00 

$1.75 
$1.50 
$1.25 
$1.00 


D' 














s 








^ 




















"^^ 


^--. 


y 
















y 


^^ 














^ 








\ 




















\ 




S^ 













































































n 



Fig. 2 



will be active, and this condition of light demand and heavy 
supply will force the price down. The diagram shows that at the 
price level of $1.75 the two curves intersect, indicating that 
buyers are willing to buy and sellers ready to sell the same 
amount at that price, which is the one price under the given 
conditions which equates demand and supply. 

Notice by the diagram that at any price above this intersec- 
tion the supply will always be heavier than the demand, in con- 
sequence of which the price will be forced downward. At any 
price below the intersection, demand will overbalance supply 
and the price will be forced upward. Whatever the actual prices 



134 



PRACTICAL ECONOMICS 



are, therefore, whether above or below the equilibrium price, 
they will always tend toward it, actuated by this balancing 
process of demand and supply working through competition. 
Just as the delicate needle of the mariner's compass ceaselessly 
oscillates to and fro, never resting, never satisfied till it points to 
magnetic north, so price, continually swinging back and forth, 
always seeks that point on the market compass that satisfies its 
nature as magnetic north does the steel needle. 



THE INTERACTION OF DEMAND AND SUPPLY ILLUS- 
TRATED BY DIAGRAMS 

The statement that prices are determined by the interaction 
of demand and supply is well illustrated by graphing the effect 



Y 

$2.25 
$2.00 
$1.75 
$1.50 
$1.25 
$1.00 



2 


:> 












si 
















^- 


^^ 




















^ 


-^^ 








"~^ 


-^ 


/ 


























^ 


---^ 


^^ 























^ 








r< 






















^ 


r^ 






\ 














s 




i 


>2 










D 































































































s- 



6 7 

Fig. 3 



10 11 12 13 



X 



of a change in either the conditions of demand or supply on the 
equilibrium price. Thus far, in order to illustrate the principle 
we have assumed the conditions of both to be constant ; we have 
taken the market conditions at a given time; but in actual life 
the conditions of either demand or supply do not remain the 
same for long, but are frequently changing, causing actual prices 
to swing up and down, as stated above. Figure 3 registers the 
effect of a change in the conditions of supply on the equilibrium 
price. 

The demand curve DD is identical witli that of Fig. 1, and 
the dotted supply curve SS marks the old conditions of supply. 
The curve S^S-, indicates an increase of supply, showing that 



THE LAW OF DEMAND AND SUPPLY 



135 



sellers are now offering larger amounts than before at the stated 
prices. At the old price of $1.75 there is a demand as before 
for 500 barrels, but the curve S-S- points to a supply of 1,000 
barrels. This increase in supply will lower prices. As the chart 
shows, the new curve S^S^ intersects DD lower down, establish- 
ing an equilibrium price somewhere between $1.50 and $1.25. 
If the supply had decreased, its curve would run above and to 
the left of S^S^, and would therefore intersect the demand curve 
higher up, establishing a higher equilibrium price, toward which 
the market prices of the commodity would then tend. 



Y 

$2.25 
$2.00 
$1.75 
$1.50 
$1.25 
$1.00 



1 


0^ 






D 


I, 




si 










^ 






V 


y 
















■^^ 


/ 


\ 


















^ 




\ 












y 








\ 


\ 








y 














\ 




s 
















D^ 































































i 5 

Fig. 4 



Figure 4 registers the effect of an increase in demand on the 
price. The new curve D-D^ runs above and to the right of the 
old curve D^D^, cutting the supply curve S^S^ at a higher point, 
and thus establishing a new and higher equilibrium price. It is 
thus easy to visualize how any change in either demand or 
supply, or in both, affects the price of any commodity sold under 
competition. It would not be possible to chart the demand or 
supply of a commodity with the exactitude that we have done 
here, though, as we have intimated, the demand and supply for 
many commodities can be estimated approximately. We have 
utilized these schedules, which are estimates of actual condi- 
tions, to illustrate the operation of a universal law. The prices 
of all commodities sold under competition are governed by it, 
and not only the prices of commodities but the services of men 



136 PRACTICAL ECONOMICS 

and women; most of us live under its sway and the amount of 
this world's goods that fall to the lot of each of us are meted 
out to us largely by this same law. 

CHANGES IN DEMAND AND SUPPLY AND PRICE 
FLUCTUATIONS 

In actual affairs changes in demand due to fickle fashion, 
changing tastes and habits, increased or decreased purchasing 
power of consumers, or changes in the general level of prices, are 
constantly causing changes in demand. At the same time new 
inventions, new discoveries of raw materials, new processes of 
manufacture, weather conditions bring about changes in the sup- 
ply of commodities. Many of these causes are so remote from 
the consumer that he is totally unaware of them; he feels, how- 
ever, their effects on prices. The more rapidly these changes 
occur, the more rapidly the price fluctuates. On a typical grain 
market, with its intricate system of world communication, which 
keep it in almost instantaneous touch with happenings affecting 
the demand and supply of grain in all corners of the earth, prices 
are fluctuating every minute or hour of the day. The demand 
and supply of many staple manufactured articles do not change 
so rapidly, and their prices therefore change more slowly. The 
estimation of the present and future conditions of demand and 
supply of commodities, then, plays a very important part in 
every-day business practice, for it is by this means that changes 
in prices can be foreseen. 

TEST QUESTIONS 

1. What is meant by the statement that the price of a commodity is 
governed by the law of supply and demand? 

2. What is demand? What is a demand schedule? 

3. State the law of demand. 

4. What is meant by elasticity of demand? Mention four commodities 
possessing elastic demand; four with an inelastic demand. 

5. What is a supply schedule? 

6. Explain how in a competitive market an equilibrium price would 
tend to be established. 

7. Show by a diagram how a change in demand will raise or lower the 
equilibrium price. 



THE LAW OF DEMAND AND SUPPLY 137 

REFERENCES 

Bohm-Bawerk, E. von, Positive Theory of Capital (Book IV, Chaps. 

I-VI). 
Cairnes, J. E., Character and Logical Method of Political Economy 

(Chap. II). 
Carver, T. N., Distribution of Wealth (Chap. I). 
Clark, J. B., Philosophy of Wealth. 

Edie, L. D., Principles of the New Economics (Chap. IX). 
Ely, R. T., Outlines of Economics (Chap. X). 
Fetter, F. A., Economic Principles (Part I). 
HoBSON, J. A., Economics of Distribution (Chap. II). 
Marshall, A., Principles of Economics (Books III and V). 
Mill, J. S., Principles of Political Economy (Book III, Chaps. I-II). 
Seligman, E. R. a.. Principles of Economics (Chap. XII). 
Taussig, F. W., Principles of Economics (Vol. I, Chaps. VIII, IX). 
Wicksteed, p. H., The Common Sense of Political Economy (Book II, 

Chap. IV). 
■Wieser, F. von. Natural Value (Book V). 



CHAPTER XIII 

THE FORCES BEHIND DEMAND; THE DETERMI- 
NATION OF INDIVIDUAL DEMAND 

THE REAL FORCES DETERMINING PRICES ARE BACK 
OF DEMAND AND SUPPLY 

The law of demand and supply is a general law. An explana- 
tion of its action does not disclose the real forces determining 
prices. We have spoken of demand and supply as forces, but 
in so doing it is evident we have used the word force loosely, for 
they are not by any means elemental forces, but rather the 
resultants of other forces working beneath them. The law of 
demand and supply expresses the relationship that exists be- 
tween the demand for a commodity and the supply of it; but 
demand and supply themselves are relationships between 
amounts and prices. By demand is meant the largest amounts 
of a commodity buyers will purchase at a certain price, or the 
highest price that will be paid for certain amounts. Likewise 
supply means the largest quantities that will be offered for sale 
at certain prices or the lowest prices that certain quantities will 
be offered for sale. After we have discovered how prices are 
determined by demand and supply, we have only scratched the 
surface of the price problem. It still remains to discover what 
determines both demand and supply. Each of these represents 
a condition and the real question at issue is: What determines 
the conditions of demand and supply? What determines the 
largest amount of a commodity buyers will purchase at a cer- 
tain price, or sellers will offer for sale? The estimation of de- 
mand, which as we have intimated, is of practical importance 
in every-day business, requires a knowledge of the forces under- 
lying demand and of the way in which they operate in the fash- 
ioning of price. 

138 



THE FORCE BEHIND DEMAND 139 

WHAT DETERMINES INDIVIDUAL DEMAND 

The total demand for a commodity is the aggregate of all the 
individual demands for that commodity. If, for instance, there 
is a demand on a local produce market for 800 barrels of apples 
at a price of $1.25, it means that there are buyers of apples in 
that market who together will purchase that quantity at that 
price. The demand schedule of a commodity is simply a total 
estimate of the amounts individual buyers will purchase at stated 
prices. Individual demand schedules added together constitute 
the demand schedule for the whole market. 

As the demand for a commodity is compounded of individual 
demands, the question narrows itself down to what determines 
the demand of the individual. What are the forces that in- 
fluence the buyer? What determines the highest price an in- 
.dividual will pay for a certain amount of a commodity, or 
the greatest quantity he will buy at a certain price? 

THE DETERMINANTS OF INDIVIDUAL DEMAND 

The highest price a normal individual will pay per unit for a 
certain amount of a commodity, or what amounts to the same 
thing, the largest number of units he will purchase at a given 
price, is determined by a comparison of the marginal utility of 
the commodity with the utility of the money he must pay. This 
is the principle that governs the buying of the individual. The 
two forces determining his demand, then, are the desire for the 
commodity and the desire for money, or as sometimes stated, 
the utility of the commodity and the utility of money. Such is 
the formal statement of the case. In the previous chapter we 
saw how the market price was influenced by the interaction of 
demand and supply. In this chapter we will notice how the price 
the individual will pay is determined by the interaction of the 
two primary forces, human want and love of money, preeminent 
in their influence on human conduct. 

THE PRINCIPLE OF DIMINISHING UTILITY 

Before we explain how individual demand is influenced by 
these forces, we will see how these forces are themselves governed 
by certain principles. Every small boy knows that the first apple 



140 PRACTICAL ECONOMICS 

tastes better than the second, the second than the third, and that 
if he but has enough, there comes a time when he even loses his 
enthusiasm for apples. Now the small boy's diminishing desire 
for apples illustrates a law of human nature as universal as 
the law of gravitation. We are all in the same boat with the 
small boy and find the intensity of our wants decreases as the 
supply of that which satisfies them increases. It follows, there- 
fore, that units of any commodity decrease in utility as their 
supply is increased, and if the supply finally exceeds our wants, 
their utility shrinks to zero. This universal experience is usually 
referred to as the law of diminishing utility and simple as it is, 
it is at the bottom of the whole price question. 

THE CONCEPTION OF MARGINAL UTILITY 

Arising out of this universal fact that similar units of a com- 
modity when used yield decreasing utilities, is the conception of 
marginal utility. The last unit to be consumed possesses the 
least utility of any; this unit is termed the marginal unit, and 
its utility is referred to as the marginal utility of the supply. If 
our small boy had a limited supply of these apples, the last one 
eaten would yield the least utility of any of the three, and its 
utility would measure the marginal utility of his supply of 
apples. Whenever the marginal utility of a supply of a com- 
modity is spoken of, it refers to the least utility possessed by any 
unit, which is always that of the last to be consumed. 

HOW MARGINAL UTILITY DETERMINES THE UTILITY 
OF EACH UNIT OF THE SUPPLY 

The conception of marginal utility is important because it 
determines the estimate we as individuals place on the utility of 
each unit of a commodity we may have in our possession or con- 
template possessing by purchase or otherwise. We have just 
noticed that similar units of a commodity when considered as a 
supply to be used possess varying degrees of utility. Similar 
units of a commodity, however, regarded as a stock in our posses- 
sion have equal utilities. This seems a contradiction, but it is 
merely a change of viewpoint. As the owner of a stock consisting 
of similar units, three apples for example, we would regard them 



THE FORCE BEHIND DEMAND 141 

all alike. If we were to dispose of one it would not matter which, 
for they each have the same utility. But let us consider these 
three apples as a supply to be used and each has a different 
utility; the first that we would eat, the greatest, the last to be 
eaten the least. If we now dispose of one of our supply, which 
will it be? Always the one with the least utility, the marginal 
apple; for we will eat the two that remain, and it will be the 
third that we will be short of. If makes no difference which 
apple is taken it will always be the one with the least utility, so 
that when we regard the three apples as a stock in our possession 
the estimate we will place on each will be determined by our 
estimation of the utility of the least or marginal unit of those 
same apples regarded as a supply to be used. 

THE LAW OF MARGINAL UTILITY 

Suppose we increase our stock and now have in our possession 
four apples. To each of these we attach the same importance, 
namely; that determined by the utility yielded by the last of 
them to be enjoyed when regarded as a supply to be used. This 
last would now be the fourth apple, which possesses less utility 
than did the third of the smaller supply; accordingly each of 
the four apples of our increased stock possesses less utility than 
the three of the previous stock. By adding a fourth apple to our 
supply we have lowered its marginal utility. For this is the 
law of marginal utility, that it varies inversely with the supply — 
increase the supply and you inevitably lower its marginal utility ; 
decrease it and you just as surely raise the msirginal utility. As, 
therefore, marginal utility determines the utility of each and 
every unit of the supply considered as a stock, it follows that 
any increase in the supply lowers the utility of each unit of any 
stock in our possession or which we might be about to place in 
our possession by purchase or otherwise; conversely any decrease 
will raise each unit in our estimation. 

MARGINAL UTILITY AND THE LAW OF DEMAND 

It is apparent that we are now involved in psychological con- 
siderations. We have just explained the principle which governs 



142 PRACTICAL ECONOMICS 

our valuations in all spheres of life and furnishes the reason 
underlying a universal fact in our experience — that the more 
of a thing we have the less we value it, and vice versa. This 
same principle underlies the law of demand, which states that 
the higher the price the smaller will be the amount sold, and 
that the larger the amount to be sold the lower the price it will 
fetch. The larger the amount, the lower its marginal utility and 
the utility of each unit to the buyers, who will naturally be 
willing to pay less per unit; the smaller the amount to be dis- 
posed of the higher will be its utility and the higher will be the 
price the buyer will pay. While these principles of diminishing 
and marginal utility explain the law of demand as applied to an 
individual, they do not completely account for the law in the 
market as a whole, for the reason, to be taken up later, that the 
utility of money varies with different individuals. 

Marginal utility therefore is a practical principle, entering 
into everyday business practice. We may be entirely unaware of 
it, yet it governs our actions just the same. In buying we are 
constantly estimating marginal utilities; it is a question of one 
more or less. Shall we buy two or three collars, ties, or if dis- 
gracefully wealthy, cars? In so doing we are comparing mar- 
ginal units, the third collar, the second necktie, with the money 
we must pay. And now that we have become better acquainted 
with these powerful psychological principles influencing economic 
activity, we are ready to see how they operate in determining 
the demand of the individual buyer. 

HOW MARGINAL UTILITY INFLUENCES THE DEMAND 
OF THE BUYER 

Every good buyer seeks to spend his income in such fashion as 
to receive the greatest amount of utility in return for the least 
expenditure of money. In purchasing a single unit of a commod- 
ity such as a victrola or a Winchester rifle, he compares its utility 
with that of some other commodity he might like to buy with 
the money he is asked to pay. If at the price asked, the utility 
of the money in his estimation overbalances that of the article, 
he refuses to buy— ''it isn't worth the money." If the price 
seems small in proportion to the satisfaction he will get out Q^ 



THE FORCE BEHIND DEMAND 143 

the article, he gains by the exchange. The highest price he will 
pay is determined by a comparison between the utility of the 
article and that of the money price. But the question is when 
he buys several units of a commodity, which as we have seen 
have varying degrees of utility, what decides his purchase? 
What determines the largest amount he will buy or the highest 
price he will pay for a certain quantity? There we bring into 
action our knowledge of marginal utility and answer by saying 
that the demand of the buyer is determined by a comparison of 
the marginal utility of the commodity with the utility of the 
money price. 

We will now see how this principle governs the buying of the 
individual, and in order to illustrate it fully we will purposely 
exaggerate the exactness with which we are able to measure the 
utility of the commodity in terms of money. In practical affairs, 
money is the only measure we can apply to utility, and we all are 
constantly measuring the utility of commodities in terms of it, 
by the comparisons we make with the marginal units of our 
purchases. We will assume that one unit of commodity utility 
is equal to the utility of one cent. In so doing we are measur- 
ing the utility of the commodity in terms of money. We will sup- 
pose that the first unit of a limited supply of a commodity, ap- 
ples or any other article of which we might purchase four or five, 
would possess 25 units of utility, the second 20, the third 15, the 
fourth 10 and the fifth 5. If the buyer were to pay in propor- 
tion to the utility of the commodity to him, rather than go with- 
out he would be willing to give (as one degree of utility equals 
one cent) 25 cents for the first unit. So much he would pay and 
no more. He would likewise be willing to pay as much as 20 
cents for the second, 15 cents for the third, 10 cents for the fourth 
and 5 cents for the fifth. But apples are not bought in this man- 
ner today and the question is what would determine the largest 
amount he would buy at any given price, let us say, 10 cents. 
His fondness for the commodity as indicated by his utility scale 
would lead him to buy two or three without any hesitation at 11 
cents apiece. He might be undecided whether to buy three or 
four. The utility of the fourth apple and the utility of 10 cents 
are equal. The utility of the fifth unit is less than that of 10 



144 PRACTICAL ECONOMICS 

cents. So that he will not pay 10 cents for it. Therefore the larg- 
est amount he will buy at the given price of 10 cents is four. He 
would lose on every unit he would buy over four. The amount 
then that he will purchase at any given price is determined by 
the balancing of the marginal utility of the commodity with the 
utility of the money he must pay for it. Just as soon as the 
utility of the last unit considered is equal to the money price he 
stops buying. It is the marginal unit acting as a danger signal 
that halts the buyer, while a comparison between its utility and 
that of the money that must be paid determines his purchase. 

This principle may be graphed as in Fig. 4. Distances along 
the line OX denote units of the supply ; distances up to the ver- 
tical line ^07 measure both units of commodity, utility, and of 
money. The curve UV is the utility curve, its downward slope 
indicating the diminishing utility of the supply, of the five units. 
The shaded section represents the utility of the fixed price of 10 
cents. The utility of the fourth apple is slightly greater than 
the utility of the price, as shown by the excess of the white in 
area four. In the fifth area the utility curve cuts through the 
shaded part denoting that the utility of the fifth unit is less 
than that of the price, 10 cents. The marginal utility of any 
given amount is measured by the height of the line of its mar- 
ginal unit. For instance, the marginal utility of a supply of four 
units is measured by the height of the line PP. The price level 
of 10 cents cuts the utility curve at P, showing that the utility of 
that amount of money is equivalent to the marginal utility of a 
supply of four units. The amount which the individual will pur- 
chase at any given price will be indicated on the diagram by the 
intersection of the utility curve and the given price level. 

THIS PRINCIPLE DETERMINES THE INDIVIDUAL'S 
DEMAND SCHEDULE 

We are now able to make up the individual's demand schedule; 
for the same principle that determined the amount he buys at 
ten cents, determines his purchase at all prices. If the com- 
modity was selling at 20 cents he would buy but two ; the third 
unit would only be worth 15 cents, possessing only a utility of 



THE FORCE BEHIND DEMAND 145 

fiiteen, so that .he would not pay 20 cents for it. His demand 
schedule then would be as follows: 

At a price of 25 cents he will buy 1 
At a price of 20 cents he will buy 2 
At a price of 15 cents he will buy 3 
At a price of 10 cents he will buy 4 
At a price of 5 cents he will buy 5. 

THE EFFECT OF AN INCREASE IN UTILITY ON INDI- 
VIDUAL DEMAND 

Any change in the buyer's desire for the commodity the utility 
of money remaining unchanged, would either increase or decrease 




his demand. If, for example, due to creative advertising or 
other causes, the commodity were raised in his estimation, his 
desire for it would be intensified, its utility correspondingly in- 
creased, he would thus be induced to purchase a larger quantity 
or pay a higher price, and in consequence the amounts in his 
demand schedule would be increased all along the line. This is 
illustrated in Fig. 6 by raising the utility curve u^u^ above 
and to the right of the old curve in Fig. 5. The marginal utility 
of a supply of four units has now increased from ten to fifteen, 
the buyer will therefore be willing to pay fifteen cents for four 
apples instead of the ten cents indicated, by the old schedule, 
or as the fifth unit has now a utility of ten he would buy five 
units at the old price of ten cents. An increase in the utility of 
the commodity has increased his demand at a price of ten cents 



146 PRACTICAL ECONOMICS 

from four to five units, and likewise through his whole demand 
schedule, which will now be: 

At a price of 30 cents he will buy 1 
At a price of 25 cents he will buy 2 
At a price of 20 cents he will buy 3 
At a price of 15 cents he will buy 4 
At a price of 10 cents he will buy 5 
At a price of 5 cents he will buy 6. 

MAXIMUM GAIN 

There is one more conception worth noting on account of its 
practical bearing on life, and that is maximum gain. The 
amount the buyer purchases is determined we have said by a 
comparison of the marginal unit with the price; we might say, 
that the buyer will keep purchasing till the last unit considered 
shows no gain in utility over that of the money that must be 
paid for it. It is evident that when a number of units are pur- 
chased at a fixed price and that price is determined by the utility 
of the marginal unit, the one with the least utility of any, that 
the buyer gains in utility on each of the preceding units. For 
the sake of illustration let us take the case of one buyer. Col- 
umn 1 below shows the utilities of successive units to him. Col- 
umn 2 denotes the utility of the fixed price of 10 cents. Column 
3 indicates the gain in utility of each unit of the commodity he 
buys at a fixed price of 10 cents. Column 4 shows his maximum 
gain. 





Utility of 




Buyer's Gain 






Successive Units 


Utility of 


Per Unit 


Maximum 




of Commodity 


Money Price 


or Loss 


Gain 


1st Unit, 


25 


10 


15 


15 


2nd Unit, 


20 


10 


10 


25 


3rd Unit, 


15 


10 


5 


30 


4th Unit, 


10 


10 





30 


5th Unit, 


5 


10 


(-5) 


25 



The fourth column shows that the buyers gain increases as he 
buys, and reaches its height at the third and fourth units. By 
purchasing three or four units he derives the maximum gain 
from the transaction. He may be undecided whether to buy 
three or four, but he will not buy five as it will reduce his 



THE FORCE BEHIND DEMAND 147 

maximum gain; five marks the point of diminishing returns to 
the buyers; every unit he buys thereafter reduces his gain. 

Should he only buy two units he fails to secure the maximum 
gain. We may say, therefore, that the buyer's purchase is de- 
termined by the point of maximum gain. 

This surplus gain accruing to the buyer has been termed by 
Marshall the English economist, ''consumer's surplus;" it is the 
difference between the total utility of the commodity and the 
total utility of the money the consumer pays for it and thus 
represents a surplus utility to the consumer. The total utility 
of the purchase of our buyer above would be found by adding 
up the successive utilities in column one of the four units he 
purchases, which together equal seventy. The total utility of 
the money he pays for these is forty, leaving him a surplus of 
thirty. 

PURCHASER'S PROFIT 

Failure to grasp this fundamental idea of the mutual ad- 
vantage of exchange has been the origin of more than one popular 
economic misconception, and much practical economic miscon- 
duct. It is plain to all that the seller gains by the sale; but 
the complementary fact that the buyer gains by a purchase has 
not always been so clear. Due to this one-sided vision, was the 
idea on which the mercantile policy of Great Britain rested in 
the 18th century, that the prosperity of the nation depended on 
"a favorable balance of trade," an idea which still persists in 
the belated minds of many of us. The old idea of an exchange 
was that of a bargain, in which one party to the transaction 
was worsted, usually the buyer, as the Roman proverb "caveat 
emptor" signifies. It seems likely that our British brethren in- 
herited the mercantile idea from this old Roman conception of 
an exchange. The idea has not, however, remained in Great 
Britain and it is to be hoped that those statesmen who hold the 
foreign policy of our country in their hands at this critical junc- 
ture have sufficient economic knowledge to realize its falsity. 

The modern conception of trade as a fair exchange, of adequate 
service rendered to the buyers by the seller, so emphasized in 
selling today, is a healthy sign of better times. Sharp prac- 



148 PRACTICAL ECONOMICS 

tices though still indulged in are not as common as in the days of 
old, nor are they countenanced by the ethics of the times. We 
are beginning to recognize that trade to be permanent, whether 
between individuals or nations, must be profitable to both 
parties to the transaction. 

SUMMARY 

To get at the real forces determining prices we must go back 
of both demand and supply. The total demand for a com- 
modity is made up of individual demands. The question then 
is, what determines the demand of the individual? The pur- 
chase of the individual buyer is determined by a comparison 
between the marginal utility of the commodity and the utility 
of the money he must pay for it. Individual demand is thus 
determined by the interaction of two opposite forces, the desire 
for commodities and the desire for money, or commodity utility 
and money utility. Similar units of a limited supply of a com- 
modity when used vary in utility, decreasing as the supply in- 
creases. The marginal utility of the supply determines the 
utility of each and every unit of that supply regarded as a stock 
in our possession. In every day life buyers are constantly com- 
paring the marginal units of their purchases with the money 
price. It is this balancing of the utility of this marginal unit 
with the utility of the money he must pay for it, that de- 
termines the demand of the buyer. Any change in the in- 
tensity of the desire of the buyer for the commodity raises its 
marginal utility and increases or decreases his demand. In fol- 
lowing out the principle the buyer secures a maximum gain of 
utility, which constitutes his profit on the purchase, a return 
in utility over and above what he gave. 

TEST QUESTIONS 

1. What are the two determinants of individual demand? 

2. What is the law of diminishing utihty? 

3. What is meant by "marginal utility"? 

4. How does marginal utility influence the demand of the buyer? 

5. What is meant by "maximum gain"? 

6. What is the difference between the old and the new conception of a 
sale? 



CHAPTER XIV 

THE DETERMINATION OF TOTAL DEMAND 

THE INFLUENCE OF THE UTILITY OF MONEY ON 
INDIVIDUAL DEMAND 

Thus far we have emphasized the influence of commodity 
utility on individual demand. We will now examine the part 
that money utility plays, which, though important, is not always 
so apparent. 

The utility of money itself varies with different individuals 
' and with the same individual at different times, due chiefly to 
changes in the general level of prices and in the incomes of 
buyers. The law of marginal utility affects money in common 
with other possessions; not perhaps to the same degree on ac- 
count of the fact that money can be used to satisfy other wants 
than that for itself; but as the most intense of these are satis- 
fied first, it follows that the more money a man possesses, the 
less he thinks of a single dollar, and vice versa. To a poor 
laborer a dollar has a far greater utility than than to a Pitts- 
burgh millionaire. In common parlance, a dollar looks twice 
as big to some than others, and this variation in the utility of 
money to different individuals will naturally make a difference 
in their demand for commodities. Imagine a clerk in moderate 
circumstances falling heir to a fortune of a half a million dollars ; 
would not the utility of a dollar shrink in his estimation and in 
consequence would not the amount of commodities he would 
buy and the prices he would be willing to pay increase cor- 
respondingly? 

THE EFFECT OF A DECREASE IN THE UTILITY OF 
MONEY ON INDIVIDUAL DEMAND 

To illustrate the above principle let us notice how a decrease 
in the utility of money will affect the demand schedule of our 

149 



150 PRACTICAL ECONOMICS 

buyer in the last chapter. We will suppose he has been lucky 
enough to fall heir to a fortune, and that a dollar seems about 
half as big as in his poorer days, which is the same as saying 
that the utility of money to him is just half what it was. In- 
stead of one cent being equal to one commodity utility as before, 
it will now be equivalent to one-half a commodity utility. He 
will be willing to pay at the rate of 2 cents for each utility, 
just twice as much as before. As his fondness for the commodity 
remains the same there will be no change in his utility schedule 
which is as follows: 

The first unit has a utihty of 25 

The second unit has a utihty of 20 

, The third unit has a utihty of 15 

The fourth unit has a utihty of 10 

The fifth unit has a utihty of 5. 

The first unit would be worth in his estimation 50 cents, the 
second 40 cents, and so on down, each double the amount it 
was worth before. He will therefore be willing to pay a higher 
price for any given amount or purchase a larger quantity at 
any given price. Before at a price of 20 cents he would buy 
no more than two, as the third unit only possessing a utility of 
15 was not worth 20 cents. Now that he is rich he doesn't hesi- 
tate to buy three and will probably buy four. He would be 
willing to pay 30 cents for the third unit if necessary and the 
utility of the fourth which is ten is just equal to the utility of 
20 cents in his estimation. 

As a poor man the highest price he could have been induced 
to pay for a given supply of three units would have been 15 
cents. Now that the utility of money has changed, he will 
pay as high as 30 cents for a supply of three units. The utility 
of the marginal unit, the one he compares with the money he 
must pay, remains the same, namely fifteen, the utility of the 
money he compares it with being half what it was, he will be 
willing to pay just double his previous price for the same utility. 
As a result the prices he will pay for given amounts and the 
amounts he will buy at given prices will be raised all along the 
line. The increased demand due to the change in the utility of 
money to the buyer is shown in Fig. 6 by the demand curve D^D^. 



THE DETERMINATION OF TOTAL DEMAND 151 

Distances along the horizontal line OX denote units of the com- 
modity, the figures up the line OY indicate prices. The two 
curves D^D^ and D-D^ register the demand before and after the 
change in the utility of money. 

WHAT IS MEANT BY THE UTILITY OF MONEY 

Our analysis reveals two elemental forces at work determin- 
ing individual demand. The first of these, human want, is a 
positive compelling force. The second, which we have termed 
the desire for money, is a negative repelling force, the nature 
of which needs a little further elucidation. What we have 
spoken of as desire for money or objectively as money utility, 
is at bottom a dislike to parting with money, and represents 
the cost of the transaction to the buyer. The money stands for 
what he must pay for the commodity, and its utility measures 
the sacrifice he makes in return for the satisfaction of his want. 
The real force of which we have taken the utility of money 
to be the measure, is the feeling of sacrifice he experiences as he 
considers what he must pay. The money he pays may stand 
in his mind for the effort he has made to earn it. The income 
of most buyers does in reality represent the effort they have put 
forth in production; which effort they have exchanged for money 
income, which money income they finally exchange for com- 
modities. It may also represent some other commodity. A 
man may be undecided whether to spend $35.00 on a set of 
Robert Louis Stevenson or a rifle. In his mind there will be a 
balancing of Stevenson and the rifle. If he decides to purchase 
the books, it is at a sacrifice of the rifle. As money is the uni- 
versal measure of value we have become so accustomed to bal- 
ance what we buy with it, to estimate the worth of com- 
modities in terms of it, that we automatically come to regard 
it as what we pay. Here for all practical purposes we may 
measure and speak of this force in terms of money. 

THE CO-DETERMINATION OF DEMAND 

Buying is a mental process in which two ideas are balanced in 
the buyers' mind, the utility of the article or the marginal utility 
of the supply he is considering, and the utility of the money he 



152 



PRACTICAL ECONOMICS 



must pay. This fact requires emphasis, as one of the modern 
theories of value, the marginal utility theory as it is commonly 
expounded by economists, through neglecting the part played 
by the utility of money, exaggerates the influence of com- 
modity utility on price. Now as we have seen the utility of the 
commodity, the power it possesses to command desire, is the 
positive and more active factor, but to ignore the utility of 
money, the power it possesses to command desire, and influence 
the decision of the buyer is to ignore one of the facts of the case 
and result in a one-sided theory of value. In practical life the 
pocketbook plays a prominent part in deciding the purchaser's 
demand, and any theory of value which does not take into 
sufficient consideration the influence of money utility, does not 
square with the facts of the case. There are two determinants 
of individual demand, the utility of the commodity and the 
utility of money; these together decide the highest price the 
individual will pay for any given amount and the largest quan- 
tity he will purchase at any given price. 

THE FORMATION OF TOTAL DEMAND 

We will now observe how the total demand for a coinmodity 
is made up out of the individual demands; tracing it from its 
rise in the springs of human wants, watching its flow down 
through the lower and lower levels of price, constantly increas- 
ing its volume by fresh supplies, like a river on its way to the 
sea. We will assume that consecutive units of a given com- 
modity possess the following utilities to four individuals A, B, 
C and D. 

Table 1 



Units 


A 


B 


C 


D 


First, 


25 


40 


15 


25 


Second, 


20 


35 


10 


20 


Third, 


16 


30 


3 


16 


Fourth, 


14 


25 




14 


Fifth, 


10 


20 




10 



THE DETERMINATION OF TOTAL DEMAND 



153 



We will also assume that the utility of one cent to D equals 
one commodity utility and that the utility of money to D is 
four times as great as to A ; thrice as great as to B ; and twice 
what it is to C. Each then will be willing to pay the following 
prices for consecutive units of the commodity: 

Table 2 



Units 


A 


B 


C 


D 


First, 


$1.00 


$1.20 


$.30 


$.25 


Second, 


.80 


1.05 


.20 


.20 


Third, 


.64 


.90 


.10 


.16 


Fourth, 


.56 


.75 




.14 


Fifth, 


.40 


.60 




.10 



Their demand schedules will be as follows: 

Table 3 



At a price of 


A 


B 


C 


D 


Total 


$1.00 


1 


2 






3 


.80 


2 


3 






5 


.60 


3 


5 






8 


.50 


4 


5 






9 


.40 


5 


5 






10 


.30 


5 


5 


1 




11 


.20 


5 


5 


2 


2 


14 


.10 


5 


5 


3 


5 


18 



The total demand for the commodity, found by adding the 
individual demands, is indicated in the last column to the right. 

ANALYSIS OF TOTAL DEMAND 

Figure 7 below charts the total demand, showing the order in 
which the units that constitute it would be purchased by the 
buyers and the utility and values of each. Height above the 
horizontal line OX measures both degree of utility and money 



154 



PRACTICAL ECONOMICS 



price. Prices are indicated up the line OY. Distances aloiTg 
the line OX measure units of the commodity, the numbers 
indicate the order of the units that will be bought, the capital 
letters the buyer. The third unit will be purchased by A, the 
small I indicating that it is A's first unit. The dotted curve 
uu registers the degree of utility of the units, the demand curve 
dd registers the price that will be paid for each unit or number 
of units and the amount that will be bought at any price. The 
utility of the third unit is for example measured by the height 
of the vertical line rising from 3 to the dotted curve, namely 
twenty-five, which is the utility of the first unit to A. Its 



Y 


D2 












45 Cts. 
40 Cts. 
35 cts. 
30 cts. 
25 cts, 




\ 














\ 
















\ 












D> 


\ 












\ 




\ 








20 cts 




\ 




\ 








15 cts 






\ 




k 






10 cts 








\ 


\ 


23^ 




5 cts. 










\ 


7)1 





















12 3 4 

Fig. 7 



price is measured by the height at which the vertical line cuts 
the demand curve, equal to $1.00, or the price that A is willing 
to pay for his first unit. The heavy black lines indicate the 
amounts that will be bought at the stated prices, or the prices 
that will be paid for given amounts. 

Figure 7 furnishes us with a complete analysis of total de- 
mand. It shows the price that each consecutive unit would 
bring by whom it would be bought, and its utility. It shows 
us the demand at any price and of Vv^hat individual demands 
it is compounded. It also shows us the relationship of utility 
to the total demand. Having thus seen how the total demand 
is built up out of individual demand, we are now ready to see 
how it is determined. 



THE DETERMINATION OF TOTAL DEMAND 



155 



THE DETERMINATION OF TOTAL DEMAND 

The question is what determines the highest price that will 
be paid for a given amount or the largest amount that will be 
bought at a given price. What for instance, decided the amount 
that will be bought at 30 cents. A and B are willing to take 
ten units at a price of 40 cents: at that price they buy their 
limit, hence they do not decide the demand at a level of 30 
cents. The amount that will be bought at a price of 30 cents is 
determined by C who is termed the marginal buyer and is re- 



Y 
1.20 
l.IO 
1.00 

so 

80 
70 
60 
50 
40 
30 
20 
10 

O 



— 


d 
\ 








K 










\ 












\ 














\ 


IN, 
















V 


K 




















\ 


\ 






u 
















\ 






\ 
















\ 








^ 




\ 


y 


\ 
\ 










^ 


^ 
















\ 




"- 


~^ 


• 


■ 


N 

> 


.V 


^^ 


^^ 


^ d 


B^ 


£! 


A-" 


B^ 


A- 


bL 


A^ 


s^ 


A' 


Al' 


C^ 


D' 


C^ 


D^ 


D^ 


D' 


o' 


D'" 


1 1 — X 



2 3 



10 11 12 13 U 15 16 17 18 19 20 

Fig. 8 



sponsible for the increase in the demand at the lower price. 
In the same way he determines the highest price at which a 
supply of eleven units of a commodity will be bought. The 
highest price ten units will bring is 40 cents. At that price 
onlj^ ten units would be purchased. If eleven units are to be 
bought they must be offered at a price to tempt C which is 30 
cents. 

Likewise, the demand at any point will be determined by the 
marginal buyer or less strictly speaking, the marginal group of 
buyers. The diagram indicates that at a price of 20 cents there 
is a demand for fourteen, the increased demand is here due to 
C buying more and the purchase of a new buyer D. A and B 



156 PRACTICAL ECONOMICS 

are not effective buyers and their purchases do not increase the 
demand at this price. We would call C and D the marginal 
buyers; their valuations determine the price at which a supply 
of fourteen units will be bought. Strictly speaking it is the last 
purchase of the last buyer which determines the highest price at 
which any amount will be bought in this case, the price that D 
is willing to pay for his second unit determines the one highest 
price at which the whole supply of fourteen would be purchased. 
Now since it is the purchase of the last buyer that decides the 
total demand, and that purchase as we have seen is decided by a 
comparison of the utility of the commodity with the utility of 
money to him, we may say that the greatest amount of any com- 
modity that will be bought at any given price or the highest 
price that will be paid for any given amount is determined by a 
comparison of the marginal utility of the commodity by the 
marginal buyer or group of buyers with the utility of the money 
price. 

MARGINAL UTILITY AND TOTAL DEMAND 

It is well to notice here the relation of marginal utility to the 
determination of total demand. The marginal utility theory of 
value as often stated by many economists, that the price of a 
limited supply of a commodity is determined by its marginal 
utility, is highly misleading. It is not the unit possessing the 
least utility of the whole supply that influences the price, but 
the unit which has the least utility to the marginal buyer. 
This unit would only possess the least utility, if the utility 
of money were the same to all buyers which it never 
is. In the case of the individual to whom, at any given 
time, the utility of money is the same, consecutive units will 
decrease in utility and the last unit, the one which influences 
the purchase price, will always be the unit with the least utility. 
Not so with the total demand, as the two curves in Fig. 8 show. 
It might be said that the unit with the least value of any deter- 
mined the value of every unit in the supply. Marginal valuation 
determines the value just as marginal utility does the utility of 
units of a stock. But the marginal valuation is not determined 
by the marginal utility of the supply, but by the marginal utility 



THE DETERMINATION OF TOTAL DEMAND 157 

of the part of the supply bought by the marginal buyer or 
marginal group of buyers. 

THE FAMILIAR LAW OF DEMAND EXPLAINED 

These two forces, the desire for commodities and the desire for 
money or dislike of parting with money working through indi- 
vidual purchases determine the demand for all commodities in 
the marts of the world. Operating in the manner we have 
described, they fully account for the familiar and universal fact 
that the higher the price the smaller the amount that will be 
bought or the larger the quantity to be bought, the smaller will 
be the price paid for it. Among the prospective buyers of any 
commodity are some who desire it more than others and some 
to whom the utility of money is greater than others. The rich 
and those who are particularly fond of the commodity repre- 
sented in our case above by A and B will purchase a limited 
supply at a high price and at a lower price some of these will 
extend their purchases. As the price falls, new buyers will enter 
the market who are less fond of the commodity or who could 
not afford to purchase at the higher prices, causing a larger 
and larger supply to be bought. 

The demand price is determined by the buyer or group of 
buyers at the margin. The actual selling price in so far as it 
is influenced by the buyers, is determined by the less eager or 
poorer buyers to whom the price of the article is a consideration. 

THE ESTIMATION OF DEMAND 

Now that we have traced the action of the fundamental forces 
underlying demand we will notice briefly some of the factors 
that influence these. The estimation of demand plays an im- 
portant part in modern business. A knowledge of the conditions 
of demand, of the number of possible buyers, their purchasing 
power, their likes and dislikes, is extremely valuable to those 
who have products to sell. While it would be impossible to refer 
to all those factors that must be taken into consideration by 
business men in estimating the demand for their products, 
among the more important are population, percentage of rural 
or urban residents, age, sex, occupation, number of families. 



158 PRACTICAL ECONOMICS 

number of wholesalers or retailers, local peculiarities, climate, 
custom, class, tastes, and income. 

While the demand for some commodities such as the com- 
moner kinds of food, clothing, soap and so on, depends to a 
great extent on mere numbers, that for most things is influenced 
by the character of the population of a district or country. 
The demand for toys depends on the number of children, that for 
sporting goods on the number of youths and outdoor lovers. 
Sex is an important factor in the case of clothes, perfumes, hair 
nets and safety razors. Occupation is the limiting factor in 
many articles. A plow or tractor manufacturer is interested 
in the number of farmers. A saw manufacturer in the number 
of carpent^ers, plus perhaps the number of home owners, as the 
recent advertising of the Disston Company suggests. The rural 
or urban percentage of a population affects the demand for those 
commodities sold chiefly to a country people or city dwellers. 
It is often important to take note of local peculiarities such as 
the demand for stogies in Pittsburgh, snuff in the South or the 
preference for whitewash to paint in some central Pennsylvania 
counties. Climate limits the demand for some things both as to 
time and place; there is little call for straw hats in winter or for 
furs in summer. The demand for light-weight clothing and porch 
furniture is heavier in summer than in winter, in California than 
in Maine. The sale of other things is confined to certain classes 
and depends on social tastes. Such is the case with silk hats, 
walking sticks and tuxedoes. Last but not least comes income. 
An article that appeals to the rich will command both a higher 
price and a more restricted sale than one used by the masses. 
The wealthy buy more expensive foods, clothing, furniture and 
autos than the poor. But on the other hand a commodity like 
the Ford car that is within the reach of the lower ranges of 
income has a tremendously larger stretch of demand than the 
Rolls-Royce type of car which is limited in its demand to the 
rich. Income statistics are highly suggestive along this line. 
The following table, taken from the figures compiled by the 
Commissioner of Internal Revenue from the income tax returns 
for 1918, indicates the rapid shrinkage in the number of pros- 
pects for commodities that depend on the patronage of the rich. 



THE DETERMINATION OF TOTAL DEMAND 



159 







Number of 


Percentage 


Percentage 


Income Classes 


Returns 


Number 


Amount 








of Returns 


of Income 


$1,000- 


2,000 


1,516,938 


34,28 


14,02 


2,000- 


3,000 


1,495,878 


33.83 


22.78 


3,000- 


5,000 


932,336 


21.06 


22.20 


5,000- 


10,000 


319,356 


7.22 


13.47 


10,000- 


25,000 


116,569 


2.63 


10.90 


25,000- 


50,000 


28,542 


.65 


6.14 


50,000- 


100 , 000 


9,996 


.23 


4.27 


100,000- 


150,000 


2,358 


.05 


1.78 


150,000- 


300,000 


1,514 


.035 


1.92 


300,000- 


500,000 


382 


.009 


.91 


500,000-1 


,000,000 


178 


.004 


.75 


1,000,000 and over 


67 


.002 


.86 






4,425,114 


100.000 


100.00 



The estimation of demand is becoming today a matter of 
scientific investigation. In the market place as in the factory 
guesswork is being displaced by accurate information obtained 
by a scientific analysis of the conditions of demand. Large 
use is made of statistics either compiled from special market 
investigations or obtained from governmental or trade agencies. 
Valuable statistics are furnished by many federal and state de- 
partments, the Bureau of Labor Statistics, especially, furnishes 
a variety of statistical data bearing on markets and prices that 
are invaluable to all who have products to sell. First hand in- 
formation from dealers and users of products is secured through 
salesmen and by means of questionnaires sent to the trade. The 
leading advertising agencies and the sales organizations of the 
larger concerns maintain research departments which conduct 
sales surveys. Market analysis is a science in itself. As a re- 
sult weak spots in sales may be detected and their remedies 
suggested. Sales standards based on actual market conditions 
instead of on past performance may be established for classes 
of consumers and territories. New products need no longer be 
launched in the dark. Basic data are provided for the direction 
of sales and advertising campaigns. Improvements are sug- 
gested in products, new uses and therefore wider markets dis- 
covered and production generally better adjusted to demand. 



160 PRACTICAL ECONOMICS 

THE CREATION OF DEMAND 

Business men today are by no means satisfied to take de- 
mand as they find it but deliberately plan to create it. Con- 
sumer wants are directed and stimulated on a large scale by 
personal salesmanship and advertising. Merchants and manu- 
facturers do not wait for customers to come to them but instead 
take the initiative, seek the consumer and sell him. It is hardly 
an exaggeration to say that the majority of commodities and 
services marketed from cash registers to insurance are sold, not 
bought ; they never would be marketed were it not for the aggres- 
sive tactics of the sellers. Fully half of the insurance policies 
sold in the last twenty years would not have been written had 
not the desire to purchase protection been deliberately created 
in the minds of husbands and fathers by the persuasive eloquence 
of life insurance salesmen. Such concerns as the National Cash 
Register Company, the Burroughs Adding Machine Company, 
The Alexander Hamilton Institute, would never have built up 
the business they have in the time they have, had they waited 
for customers to come in and buy. They foresaw a need, pro- 
duced a product to meet it and then organized and sent out a 
force of trained salesmen to sell their products. These concerns 
have relied primarily on personal salesmanship supplemented 
later by advertising to build up the demand for their products. 
Now the essence of salesmanship is the creation of the desire 
to buy in the mind of the prospect. The difference between an 
''order taker" and a "salesman" is that the order taker simply 
gives the buyer what he asks for, whereas the salesman creates 
the desire to buy on the part of the prospect in whose mind no 
such desire previously existed. This is truly termed in sales 
parlance "creative selling." From the viewpoint of economics 
what is created is a demand for a product. Salesmanship is an 
art requiring considerable ability. Much attention is paid by 
business concerns in the selection of their salesmen and in train- 
ing them. 

Personal salesmanship has its limitations; one salesman is 
only able to call on a limited number of prospects a day whereas 
by means of printed matter the product can be brought to the 



THE DETERMINATION OF TOTAL DEMAND 161 

attention of millions. The use of advertising as a means of 
creating and stimulating demand on a large scale is of very- 
recent origin. Its growth in the last twenty years has been re- 
markable. Today it is the most powerful marketing force em- 
ployed to sell commodities. Its phenomenal growth may be at- 
tributed to several causes; first, contrary to the belief of many, 
it tends to reduce the cost of production, both the manufacturing 
cost and the selling cost. By virtue of its ability to create de- 
mand on a large scale it secures volume production and this 
lowers factory costs. Though the advertising appropriations of 
many concerns may run into millions a year the percentage 
of advertising cost to sales is remarkably low, (ranging from a 
fraction of 1/66 of 1 per cent for example in the case of the 
California Fruit Growers' Exchange) , to 7 per cent or 8 per cent 
for some of the smaller or higher cost concerns. It is usually 
a cheaper method of marketing than personal salesmanship. 
William R. Basset, President of Miller, Franklin, Bassett & 
Company, writing in Printers' Ink of April 20, 1922, cites the 
following case from his own experience: 



The item sold at, 

Manufacturing cost, $40 

Selling cost using expensive specialty salesmen, 45 

Profit, $5^ 

Profit on sales, 15 per cent 

Under a changed policy, the advertising appropriation was greatly 
increased but the sales were easily closed by mail: 

Selling price, $60 

Cost to make, $40 

Cost to sell, 10 

Profit, 1^ 

Profit on sales, 16 per cent 

The sales volume in dollars increased 44 per cent. The reduced 
selling price was the sales argument. It not only made the product 
easier to sell to the old market, but at the low price new buying strata 
were reached. 

But the real secret of the power of advertising as a marketing 
force lies in the fastness with which it works. Time is money in 



162 PRACTICAL ECONOMICS 

modern business. Advertising speeds up demand. Business men 
are not satisjEied to let the demand for their products grow up as 
of old naturall}'' by itself. Through the use of newspapers, mag- 
azines, car cards, electric signs and the mails, they influence the 
minds of millions simultaneously. The rapidity and extent to 
which the tastes of a nation are subject to stimulation and direc- 
tion by advertising is little short of marvelous. A nation-wide 
demand is created for a new product in a surprisingly brief time. 
The automobile furnishes a good example. The remarkably 
rapid growth of this industry is due largely to the fact that it 
has employed advertising on an extensive scale to market its 
product. In 1899 there were but 3,700 cars manufactured, in 
1921 the number of cars in use was estimated at nine millions 
or about one car for every twelve people. 

Some of the latest achievements of advertising have been in 
connection with fruits. The California Association Raisin Com- 
pany hit on the happy idea of a nickel package of "Sun Maid" 
raisins. The first package was put on the market accompanied 
by a barrage of advertising Sept. 1, 1921; by Oct. 1, orders were 
received for three hundred million packages. Up to April, 1922, 
over 17,000 tons of "Sun Maid" raisins have been sold in nickel 
packets. The consumption of raisins has been doubled in the 
last five years mainly by advertising; the consumption in 1921 
equalled 200,000 tons. In an address before the convention of 
Associated Advertising Clubs of the World at San Francisco in 
July, 1918, Don Francisco, Advertising Manager of the Cali- 
fornia Fruit Growers' Exchange, stated that in the ten years 
since the orange growers have been advertising, the consump- 
tion of California oranges in the United States and Canada has 
increased from ten million boxes to eighteen million boxes a year 
or an increase in consumption of 80 per cent, a rate of increase 
four times that of population. 

A rather interesting example of the difference between the 
old and the new methods of building up a market is seen in the 
case of William Mickelberry of Chicago. Twenty-five years ago 
Mr. Mickelberry found in his mother's recipe book the direc- 
tions for making a certain kind of sausage which had been a 
favorite with the family for many years. He decided to try to 



THE DETERMINATION OF TOTAL DEMAND 163 

capitalize it. With his wife's aid he made some up and the 
next day started out with a basketful on his arm. He suc- 
ceeded in selling it to some neighboring retailers. The quality 
was so good the customers of these retailers asked for more. 
This formed the start of a business that in twenty-five years 
was built up by personal saelsmanship plus the reputation of 
the goods. No advertising was done up to very recently, the 
company taking it for granted that the high retail price of the 
sausage kept it from having a wider market. An investigation 
proved that this was not the case; there existed a really wide 
potential market for the product. A selling and advertising 
campaign was planned to extend over several weeks. Space 
was taken in the newspapers, eleven salesmen were drilled in 
every detail of the advertising and then sent out to secure orders. 
In fourteen days 1,382 retailers were obtained. It was such a 
revelation that the company, swamped with orders, had to call 
off the advertising temporarily while it made manufacturing ar- 
rangements to take care of the multiplied demand.^ 

Here is a company which for twenty-five years gradually 
developed its sales to a point which it considered to be its limit. 
By means of a sales survey followed by an intensive selling 
campaign it tripled in fourteen days the demand it had slowly 
built up in the course of twenty-five years. The company is 
now reaching out through the newspapers and magazines for na- 
tional distribution. Thus does the modern concern by the use 
of modern marketing methods build up almost overnight a de- 
mand for its product. 

Another feature of advertising which has no doubt contributed 
to its growth is the control it gives the manufacturer marketing 
through middlemen over the ultimate demand for his product. 
Hitherto the manufacturer depended on the wholesaler or retailer 
or both to push his commodity. If they failed to do so he had 
little recourse. By packaging and branding his product and 
advertising it directly to the consumer he is able to control de- 
mand at its source. The retailer is anxious to stock the ad- 
vertised article because it is demanded by his customers, the 
wholesaler likewise on account of the retailer demand. Thus 

^Printers' Ink, 1922. 



164 PRACTICAL ECONOMICS 

by reaching over the heads of the middlemen to the ultimate 
consumer the manufacturer is no longer at the mercy of the 
middleman but is able to maintain a measure of control over the 
demand for his product even after it has left his possession. He 
is also able to cooperate better with the wholesaler and retailer 
and aid them in increasing their sales. 

Advertising has been accused of increasing the cost of living. 
In one sense this may be true; in another it is not. When it is 
inferred as it often is that advertising by adding to the cost 
increases the price of commodities to the consumer the inference 
is erroneous as we have seen. It has also been asserted that 
advertising increases the cost of living by overstimulating de- 
sire espeqially the desire for luxuries. There is no doubt, of 
course, that advertising does stimulate wants and wants for 
things people could do without, but whether it overstimulates 
wants is a question. Advertising is simply a method of selling, 
of persuading a buyer to buy and selling has never been con- 
demned. It cannot be accused of unduly influencing the mind of 
the buyer, or using mental "strangle holds" to force buyers to 
buy as is sometimes done in personal salesmanship when "strong 
arm" methods are used. It employs much milder methods if 
more subtle, and relies on the law of averages in reaching large 
numbers rather than on force. By making things known to 
large masses of people, by bringing them to their attention in 
an attractive manner, by making plain the service they are able 
to render, emphasing quality, people are naturally led to want 
these things. It is true this is all carried out in a very scientific 
manner. Advertisers are practical psychologists; their copy is 
not prepared blindly. Human instincts are studied and the ap- 
peal is designed and aimed to reach the buyer's heart. They 
use science rather than force but there is no sin in science. 

There is nothing inherently wrong in creating a want for a 
thing unless that thing is bad, in which case it should not be 
sold by any method. In this respect it must be admitted ad- 
vertising has pretty well cleaned house. Most of the leading 
papers and magazines exercise a rigid censorship over their 
advertising columns. Fake and injurious articles are fairly well 
excluded. Then too, the increasing confidence of the public in 



THE DETERMINATION OF TOTAL DEMAND 165 

advertised articles is based on good business grounds. It does 
not pay to spend money in advertising a commodity that is 
not what it is claimed to be. Repeat sales would not be made 
and no matter how much money would be spent to advertise it 
permanent sales could not be maintained. The first requisite 
for any commodity to be permanently advertised is genuine 
utility. 

It may be true that we are living at too fast a pace today; 
that advertising, city life and other factors tend to over-stimu- 
late our wants, to render us too ambitious. One thing even here 
should be noticed in respect to the part advertising plays in this 
tendency. While it is true that people's wants are stimulated 
by it, that it tempts them to spend, it also urges them to save. 
Some of the heaviest advertisers today are the banks and in- 
surance companies which are persuading people to save and in- 
'vest in their future. Likewise our educational institutions are 
inciting men to invest their income in their education. And 
while it is true that advertising does deter us from spending 
the whole dollar on bread for our bodies, in tempting us to buy 
some hyacinths for our souls, that may not be entirely an evil. 
Most assuredly advertising has pla^^ed a powerful part in rais- 
ing the standard of living of the masses. It has hastened the 
introduction of new inventions and improvements to the nation 
at large. It has helped equip the factory and office with labor- 
saving machinery and furnished the homes of millions with com- 
fort and conveniences. Steam shovels, typewriters, telauto- 
graphs, telephones bathtubs, open plumbing, victrolas, automo- 
biles, radio sets all have been helped into common use by ad- 
vertising. 

SUMMARY 

By demand is meant the largest amount that will be bought at 
a given price or the highest price that will be paid for a given 
amount. The point of our inquiry has been to discover what 
determines this amount or price and how it is determined. 

As the total demand is made up of individual demands we 
first found what decided the purchase of the lone buyer; the 



166 PRACTICAL ECONOMICS 

desire for the commodity and the desire for money or objectively 
speaking, commodity utihty and money utility. 

These two forces operate by means of a comparison in the 
buyer's mind between the marginal utility of the amount he con- 
templates purchasing and the utility of the money he expects to 
pay for it. 

We next saw how the individual buyers made up the total 
demand. We found that the total demand was determined by 
the group of buyers at the margin or to be exact the marginal 
buyer — that the highest price that a given amount would be 
bought at, is determined by the price the group of buyers at 
the margin, or to be accurate the marginal buyer will pay. 

We may say, therefore, that the highest price that will be paid 
for a given amount or the largest amount that will be pur- 
chased at a given price is determined by the comparison made 
by the marginal buyer between the marginal utility of the last 
part of the supply he purchases and the utility of money to him. 

The practical importance of the two forces determining de- 
mand is well illustrated by modern sales practice and in par- 
ticular by the tremendous scope of present-day advertising. 

TEST QUESTIONS 

1. How does the utility of money vary with different individuals? 

2. Explain how a decrease in the utility of money to an individual will 
increase his demand. 

3. What tv/o ideas in the mind of the buyer determine his demand? 

4. Explain how the market demand for a commodity is made up of 
individual demands. 

5. What buyer determines the market demand under conditions of free 
competition? 

6. What are the two forces determining the prices of commodities under 
the action of the law of supply and demand? 

REFERENCES 

Cairnls, J. E., Character and Logical Method of Political Economy 

(Chap. I). 
Carver, T. N., Distribution of Wealth (Chap. I) ; Principles of Politi- 
cal Economy (Chap. XXII). 
Clay, H., Economics for the General Reader (Chap. XV). 
P]ly, R. T., Outlines of Economics (Part II, Chap. X). 
Hadley, a. T., Economics (Chap. III). 



THE DETERMINATION OF TOTAL DEMAND 167 

HoLLiNGWORTH, H. L., Advertising and Selling. 

KiTSON, H. D., The Mind of the Buyer. 

Marshall, A., Principles of Economics (Book III). 

Mill, J. S., Principles of Political Economy (Book III, Chaps. I and II). 

Mitchell, W. C, The Backward Art of Spending Money. 

Nicholson, J. S., Political Economy (Chap. III). 

Pantaleoni, M., Pure Economics (1898, Part II, Chaps. I-III). 

Scott, W. D., The Psychology of Advertising — Theory and Practice of 

Advertising. 
Seager, H. R., Principles of Economics (Chaps. V, VI). 
Sedgwick, H., Principles (Book II, Chap. II). 

Seligman, E. R. a., Principles of Economics (Part III, Chaps. XV-XVII). 
Taussig, F. W., Principles of Economics (Chaps. VIII, OX). 
Tipper and Others, Principles of Advertising. 
Walker, F. A., Political Economy (Part III, Chap. I). 
Whitehead, H., Principles of Salesmanship. 
WiCKSTEED, P. H., The Common Sense of Political Economy (Book II, 

Chaps. I, II, III). 
WiESER, F. VON, Natural Value (Book II, Chaps. 1-4). 



CHAPTER XV 

THE FORCES BEHIND SUPPLY; COST OF 
PRODUCTION 

THE QUESTION OF SUPPLY 

Having uncovered the forces influencing prices on the buyers' 
side of the market and noticed their modus operandi in 
determining demand, we will now consider the domain of the 
seller. Post-war high prices provoked a lively speculation on 
the part of the public as to their causes and justification. The 
man who paid $10 for a pair of shoes that before the war could 
have been bought for $5.00, or 50 cents for two collars that 
formerly cost him 25 cents, though aware of the increased cost 
of production to the maker, was apt to suspect that part of the 
high prices might be due to someone pocketing abnormal profits. 
He may even have been tempted to wonder sometimes whether 
there was any limit to the price the seller was able to charge. 
Governmental price-fixing of commodities during the war has led 
to a new interest in the question: What is a fair and just price? 
All of which has kindled in the public mind an active curiosity 
as to the nature of the sellers' influence over prices and a desire 
for more light on what takes place in the private office of the 
manufacturer and merchant when prices are under consideration. 
The question is : What determines the prices which sellers charge 
for given quantities of a commodity, or the quantities they will 
be willing to sell at given prices? 

THE DETERMINANTS OF SUPPLY 

The total supply of a commodity like the total demand, is the 
sum total of the individual supplies. If the supply schedule 
indicates that a million units will be offered for sale at a price 

168 



THE FORCES BEHIND SUPPLY 169 

of $1.00, it signifies that competing sellers of the commodity 
are together ready to supply that amount at that price. 

The lowest price at which any individual producer will be 
willing to offer any given amount of a commodity, will be 
determined by his comparison between the disutility or cost of 
his product, and the utility of the money price he expects to 
receive. This is the principle governing the selling price of the 
individual and the two forces involved are desire and cost; 
desire for the money price, and the cost that which must be 
incurred in the production of the commodity. Just as the buyer 
compares the utility of the commodity he is about to purchase 
with the utility of something else costing the same amount, so 
the seller compares the cost of producing the commodity with 
the utility of the money return he expects to receive. Both seek 
.a gain in the transaction, the buyer in the excss of the com- 
modity utility he receives over that of the money payment he 
makes; the seller in the excess of money utility he can obtain 
over the cost of production. The price the buyer is willing to 
pay represents the utility of the commodity in terms of money; 
the price the seller is willing to take represents the cost of pro- 
duction in terms of money. 

As cost of production is the chief factor limiting the supply 
of freely reproducible commodities sold by competitive producers, 
the point of our inquiry will be to trace its influence on supply 
prices and amounts. Before doing so, however, we will look a 
little closer at this force which plays such an important part in 
modern industry. 

THE MEANINGS OF "COST" 

Cost is a term possessed of a dual personality. In political 
economy cost stands for the efforts, sacrifices and risks incurred 
by producers in the production of commodities. It is the exact 
opposite of utility which refers to the satisfaction to be obtained 
from the products of industry. Hence the word disutility is often 
used in place of cost. Cost represents the unpleasant in pro- 
duction, utility the pleasure embodied in the fruits of that 
unpleasantness. 

But in the vocabulary of commerce cost stands for the money 



170 PRACTICAL ECONOMICS 

expenses incurred by enterepreneurs. To a business man "cost" 
means the money outlay required for the production of his 
product; this plus his profit constitutes his selling price. 

All the money expenses of production, including the profit of 
the entrepreneur, are termed in political economy either money 
costs, or expenses. 

To avoid confusion we will use the term Real Cost when 
referring to the efforts, sacrifices and risks involved in produc- 
tion. Money Cost when referring to the money expenses, while 
Cost will be used in its usual commercial sense, as the money 
expenditure of the individual business concern. 

REAL COST AND SUPPLY PRICE UNDER SIMPLEST 
CONDITIONS 

In the case of an individual producing a commodity entirely 
by himself for sale, the price in expectation of which he would 
be willing to undertake the work must repay him for the efforts, 
sacrifices and risks he undergoes. A case in point would be the 
building of a log cabin in the woods for a summer visitor, by a 
frontiersman who obtains all his materials from the forest and 
performs all the work himself. The lowest price for which he 
would be willing to build the cabin, must be equal in his mind to 
the trouble he incurs, or he would not tackle the job. A fair 
and reasonable price would be one that would amply remunerate 
him for all the efforts, sacrifices and risks he had incurred in the 
course of the undertaking. 

COMPLEX NATURE OF REAL COST IN MODERN 
PRODUCTION 

But commodities today are brought into existence by the 
cooperative action of various kinds of laborers, capitalists and 
entrepreneurs, each contributing his specialized quota, as the raw 
materials flowing through the channels of production are by con- 
secutive processes transformed into finished products. The real 
cost of a finished product is, therefore, the sum total of the 
efforts, sacrifices and risks incurred by all those who have con- 
tributed in these various ways to its production, and is even 
in the case of the most simple commodity a very complex thing. 



THE FORCES BEHIND SUPPLY 171 

Consider for a moment the varied expenditure of human effort 
involved in the making of a pair of shoes; beginning with the 
work done by the producers of the raw materials, the ranchmen 
and their cow punchers on the plains, the darkies in the cotton 
fields, the miner drilling in the bowels of the earth, the packers 
and their men in Chicago, the tanners engaged in their odori- 
ferous tasks, the operatives working eight or nine hours a day 
in the noisy textile mills, the shoe manufacturer with his sales- 
men, clerks, and factory hands, and lastly the only one we are 
brought into contact with, the retailer who sold them to us. 
Add to these the labors of the miscellaneous army of supplemen- 
tary workers, such as the makers of the machinery and equip- 
ment used, those engaged in transporting these various prod- 
ucts, — the railroaders on land, the sailors on the sea, the 
capitalists and bankers who have supplied the capital, and we 
have a partial conception of the accumulation of human toil that 
enters into the real cost of a pair of shoes. 

HOW REAL COST IS CONVERTED INTO MONEY COST 

The real costs of production are continually being converted 
into money costs, as the raw materials travel along the channels 
of production toward the ultimate consumer. All along the route 
as each producer does his bit, he receives a money payment in 
return for the part he has played in production. The money cost 
of a finished product is the sum total of the money payments 
made to all those who directly or indirectly have aided in its 
production. Just as the real cost of any finished product is the 
sum total of the efforts, sacrifices and risks incurred during the 
course of its production, so its money cost is the sum total of 
the money expenses that have been assessed against it from its 
inception. 

At any stage in the production of a commodity the selling 
price sums up the money costs chargeable to that particular 
commodity up to that time, plus the seller's profit. A manufac- 
turer's selling price of shoes, for instance, is determined by his 
cost of production, plus his profit. This cost consists of money 
payments for materials, machinery, labor, etc. To this money 
outlay he adds a sum sufficient to remunerate himself for his 



172 PRACTICAL ECONOMICS 

own trouble and risk. What he pays in wages rewards those 
who have labored with him. What he pays for raw materials 
and machinery covers the cost of their production, out of the 
price he pays for leather, the tanner likewise is repaid for his 
money outlays and receives a profit, while he in turn in the 
price he pays for hides reimburses the packer and his men. 

The price the retailer pays for shoes covers all the money costs 
incurred by previous entrepreneurs from the producers of the 
raw materials to the shoe manufacturer ; to this the retailer adds 
his own cost, which, plus his profit, constitutes his selling price. 
And the price to the ultimate consumer includes all the money 
costs assignable to the commodity in the course of its production. 

MONEY COST AND SUPPLY PRICE 

Money costs are the payments necessary to induce the various 
producers to contribute their shares to production. We may 
divide the producers into laborers, capitalists and entrepreneurs, 
and look upon the money costs as the payments that must be 
made to these agents of production to induce them to furnish 
the requisite quantities of labor, capital and organization. In 
which case the money costs are the supply prices of the quan- 
tities of the factors of production, and the supply price of the 
finished product is the sum total of the supply prices of the 
factors of production that have been demanded to bring it into 
being. 

We thus see how in the devious course of modern production, 
real cost crystalizes into money cost and money cost by a 
process of aggregation builds up the supply price of the finished 
product. Thus in this indirect and roundabout way, the supply 
price of a finished product is that which has been necessary to 
induce those who have been instrumental in its production to 
play their part. 

RELATION OF REAL COST TO SUPPLY PRICE OF LAND 

In our account of the evolution of real cost into supply price 
we omitted, in speaking of the supply prices of the factors of 
production, any mention of the supply price of land or natural 
products. Rent is an important item in the costs of business 



THE FORCES BEHIND SUPPLY 173 

men; and in so far as commercial rent is due to improvements 
on land or natural resources, real cost enters into it and influences 
the supply price of this factor. It enters it, however, in the form 
of labor, capital, or organization and should be credited to these 
agents of production. 

Rent from the viewpoint of political economy, however, is the 
return paid to owners of land for the part their land, strictly as a 
natural product, plays in production. Now the land in the 
United States or the coal or iron lying beneath that land is cer- 
tainly not the fruits of man's labor, and its supply therefore is 
not influenced by real cost. The supply of land is limited in the 
first place by nature and is further limited and controlled so far 
as its productive use is concerned by private ownership. The 
supply price of the factor land then is not the sum necessary 
to induce owners of land or natural resources to put forth any 
production effort, but to induce them as owners to allow their 
land to be used for production purposes. 

COST OF PRODUCTION 

The supply of produced commodities today is directly regu- 
lated by entrepreneurs, be they sole proprietors, partnerships, or 
corporations; and they reckon their costs in terms of money. 
These decide what shall be made and how, coordinate the other 
agents of production, pay them for their services, assume the re- 
sponsibility of marketing the product, and decide on the price. 
Their costs are the sums they pay to the other agents of pro- 
duction; these, plus their profits, constitute their selling price. 

The modern business concern is confronted with no more 
difficult task than to determine accurately its cost of production. 
The way commodities are fashioned today by the thousand, in 
complex organizations of highly specialized workers and ma- 
chines, arranged in departments, each performing its particular 
function, makes the finding of unit cost a problem of no mean 
order. It is scarcely to be wondered that up to a few years ago 
the great majority of concerns preferred to guess at their costs, 
a practice by no means extinct. Keen competition, however, and 
the splendid work carried on just previous to America's entrance 
into the war, by the Federal Trade Commission under the Hon. 



174 PRACTICAL ECONOMICS 

E. N. Hurley in reference to cost finding, followed by the re- 
quirements of the government during the war, including also the 
income tax, have worked a revolution in the field of costs. Guess 
work is being replaced by accurate knowledge, and more than one 
concern has discovered to its surprise it has been selling one or 
more of its products actually at a loss. Many of the best brains 
in business have been engaged on cost problems, the universities 
throughout the country have cooperated, with the result that a 
science of cost accounting has been developed and a goodly num- 
ber of trained cost men are being prepared in our university 
schools of commerce every year for this important branch of 
work. Now that war is over and the nation is entering on a new 
era of intense international competition, less than ever can busi- 
ness men afford to play blind man's buff with their costs. 

A SIMPLE ANALYSIS OF MANUFACTURING COST 

What constitutes cost may perhaps be best illustrated by a 
brief survey of manufacturing costs, in which field cost finding 
has been carried to its highest degree of efficiency. The Federal 
Trade Commission as a result of its exhaustive research and 
study of the cost of production of a large number and variety of 
businesses, presents in document No. 1356 entitled "Funda- 
mentals of a Cost System for Manufacturers," a simple yet com- 
plete analysis of manufacturer's costs. 

The three elements of cost are Material, Labor, and Overhead 
Expense. The first two of these are divided into direct and 
indirect. 

Direct Material is that which forms part of some particular 
job, or which can be charged directly to a unit of product. Indi- 
rect material is that which cannot be located as belonging to any 
job or unit. 

Direct Labor is that which is applied directly to a particular 
job or unit of product. Indirect labor is that which cannot be 
located as belonging to any particular job or unit, as the labor 
of a works manager or superintendent of foremen. 

Direct Material and Direct Labor constitute what is generally 
known as Direct or Primary Cost, and shows the actual amount 
of cost directly chargeable to a particular job or unit of product. 



THE FORCES BEHIND SUPPLY 



175 



Overhead Expense is expense of every kind connected with the 
business, none of which can be located as belonging to a par- 
ticular job or unit. These expenses, while part of the cost, are 
general, so cannot reach the job or unit directly, hence a method 
must be devised for them to reach the cost sheet in an indirect 
manner, and so that each job or unit will receive its fair propor- 
tion of the total. For this reason overhead expense is sometimes 
termed indirect cost. 

Overhead expense is divided into two classes. Factory Over- 
head, which consists of items directly belonging to factory pro- 







Profit 
25 cts. 


SelUng 
Price 

$1.75 






General 
Overhead 
Shipping 
SelliQg 
Geueral 
25"ctsr" 

Factory 
Cost 
$1.25 


Total 
Cost 
$1.50 






Factory 
Overtiead 
Fixed & 
Variable 
50 cts. 




Direct 

Labour 

Cost 

50 cts. 


Prime 
Cost 

75 cts. 


Direct 

Material 

Cost 

25 cts. 





Fig. 9 



duction, General Overhead, which is expense not directly con- 
nected with the factory. 

Factory overhead is split into two parts, Fixed and Variable 
charges. Fixed charges consist of building expense or rent, 
power, insurance, taxes, and depreciation. Variable charges, the 
controllable expenses of factory operation, complete factory 
overhead, and include such items as indirect labor, repairs, lubri- 
cating oils and miscellaneous supplies. 

Direct cost plus factory overhead constitute what is usually 
termed Factory Cost. 



176 



PRACTICAL ECONOMICS 



The next step, now that the goods are completed and placed in 
the storeroom as finished goods, is to compute their share of 
General Overhead, which consists of the shipping, selling, and 
General Expenses of the business. 

Ship-ping Expense includes a proportion of fixed charges, freight 
or drayage, shipping clerks' wages, supplies, and incidental ex- 
pense items. 




Fig. 10 

Selling Expense involves such items as salaries and expenses 
of sales force on the road and in the office, advertising, cata- 
logues, cost of handling cancelled orders, etc. 

Last but not least come general expenses, such as officers' sal- 
aries, office expenses, insurance, defective work, taxes, interest 
when charged and other items of a general nature. 

With the adding of general overhead to factory cost the riddle 
is solved and total cost is found — this plus profit constitutes 
the selling price. 



THE FORCES BEHIND SUPPLY 177 

This analysis shows how cost mounts up by a series of steps 
to the selling price, and Fig. 9 illustrates the process. Figure 10 
shows at a glance the three chief elements of cost with their 
divisions and subdivisions. 

JOINT COST AND SUPPLY PRICE 

Many commodities are produced under conditions of joint 
cost, the productive process gives birth not merely to a single 
product, but to twin, triple and in some cases a whole family of 
kindred products. These are often termed joint products and 
include by-products; familiar examples are sugar and molasses; 
cotton and cotton seed; beef and hides, with their numerous 
retinue of by-products; coke and coal tar with its varied 
progeny; and a legion of others whose numbers are constantly 
being augmented by scientific research. 

■ When two or more commodities are produced entirely under 
conditions of joint cost, such as sugar and molasses, both of 
which emerge from the same plant and neither can be said to 
possess a distinct supply price of its own, to neither is it possible 
to attribute a definite proportion of the common cost. They do 
have a collective supply price, the sum total of their joint costs, 
for less than this they will not continue to be produced. The 
actual price of each will depend on the condition of demand for 
each. A share of the joint cost may be assigned arbitrarily to 
each according to the judgment and interest of those concerned. 
One method of segregating the cost of a principal product from 
a by-product is given by the Tariff Commission in its report on 
the costs of Production in the sugar industry. 

If for the marginal factory the total cost of producing both sugar and 
its by-products is $140 per ton of sugar produced, and the receipts for 
the by-products are $20 on every ton of sugar produced, then a price 
of $120 per ton would permit that factory to continue without loss, 
while all the lower cost producers would make a profit. In such a 
view of the case the cost of producing sugar may be said without any 
great impropriety to be $120 per ton. 

In the case of two or more commodities produced partly under 
joint cost, but which incur special costs in the separate sub- 
sequent processes which each must undergo to arrive at com- 



178 PRACTICAL ECONOMICS 

pletion, the price of each must at least cover its special cost. 
The joint cost will be assigned to one, or divided between them, 
as judgment dictates or demand decides. In the recent case of 
the U. S. vs L. F. Swift et al., the following illustration was 
presented of the so-called "Margin System," the packers' uni- 
form method of figuring the cost of meat. 

Swift buys a steer weighing 1,200 pounds at $5 per hundred weight, 
making the cost of the steer $60. To this Hve cost he adds, say 12.35, 
the amount agreed upon by the members of the pool as the allowance 
that will be made to cover the cost of killing and dressing the meat, 
called the killing charge. That makes the total gross cost of the carcass 
$62.35. From this amount would be deducted an agreed amount of, 
say 4 cents per pound for the hide, weighing, we will say, 70 pounds, 
making a total allowance of $2.80. There is also to be deducted, say 
3 cents a pound for fat, and we will assume that the animal produces 
about 80 pounds of fat, making a total allowance on that account of 
$2.40. The sum of these two allowances, or $5.20, would be deducted 
from the gross cost of the carcass, $62.35, leaving the net cost of the 
carcass $57.15. Assuming that the animal produces 600 pounds of 
fresh meat, if you divide the net cost of the carcass, that is $57.15, by 
the number of pounds the meat produces, 600, it will give a price of 
93^c per pound, the test cost of the meat. That is, on that lot of meat 
that is slaughtered on that particular lot of cattle slaughtered by 
Swift & Co. 

By this ingenious method the cost of beef is determined by 
deducting from the joint cost, sums representing the value of the 
by-products. The fairness of the result rests upon the deductions 
which have been made. If they are based on the market prices 
of hides, fats, etc., the apportionment of cost will be just, but 
should the amounts deducted be less than market values, the 
share of the joint cost assigned to beef, will be in excess of what 
it should ; and this is what the packers are accused of. 

This uniform method of figuring cost was made the basis of 
an agreement on prices as follows: 

As the meat is shipped out to the different branch houses throughout 
the United States, instructions are given that all the branch-house 
managers must work, as they call it, for cost or for plus 50 or minus 50, 
because this cost which was sent out has generally been largely in 
excess of the actual cost of the fresh meat — that is to say, the allowance 



THE FORCES BEHIND SUPPLY 179 

made on account of hides and fat were not made on the basis of the 
market prices of hides and fat, but were made on an arbitrary basis much 
below the market price of hides and fats, so that it was possible to work 
on what was called a minus margin and at the same time dispose of 
fresh meat at a substantial profit, so that instructions might go out 
to work uniformly for minus 50 or for cost. 

TEST QUESTIONS 

1. What is the chief factor in determining supply? 

2. What is meant by "real" cost? By money cost? 

3. Does "land" have any "real" cost? 

4. Make an analysis showing the elements of manufacturing costs, 

5. What is meant by "joint cost"? 

6. Describe the "margin system" of the packers. 



CHAPTER XVI 
INFLUENCE OF COST ON SUPPLY 

In the preceding chapter we saw how in our complex indus- 
trial system real cost underlies the supply prices of commodities, 
influencing them indirectly through the supply price of the 
factors of production employed to bring them into being. We 
saw also that the supply was directly influenced by money cost, 
operating through the cost of production of entrepreneurs, an 
analysis of which we have presented. It is the entrepreneur who 
runs the supply train ; it is his hand which is on the throttle. The 
amount he will produce and the price he will be willing to sell 
at will be determined directly by his cost of production. Our 
next step will be to see HOW the amount and the price of the 
supply are governed by cost. We will find that cost influences 
supply in three ways: (1) By increasing as the volume of pro- 
duction increases; (2) by decreasing; (3) by remaining constant. 

INFLUENCE OF INCREASING COST ON SUPPLY PRICE OF 
INDIVIDUAL PRODUCER 

In the case of an individual producing a commodity the unit 
cost of which increases with the amount he produces, the price 
at which he will be willing to furnish any given quantity, or 
the quantity he will be willing to sell at any given price, will be 
determined by the cost of the last or marginal unit. 

If, for instance, additional units of a commodity are produced 
at the following cost: 

The fifth at a cost of $1.00 
The tenth at a cost of $1.10 
The fifteenth at a cost of $1.25 
The twentieth at a cost of $1.50, 
180 



INFLUENCE OF COST ON SUPPLY 181 

the largest amount the producer will be willing to supply at a 
price of $1.10 will be ten. He makes a gain on each unit up to 
the tenth, the cost of which just equals the price he is offered. 
As every unit over this amount costs more than $1.10, he will 
not be willing to supply more than ten at that price. And so 
with any given price, he will be willing to continue production 
up to the point where the cost of the last unit equals the price. 

In the same way the price at which he would be willing to 
furnish any given amount would be determined by the cost of 
the last unit. He would not be willing to supply ten units for 
$1.00 a piece, as he would suffer a loss on each unit he produced 
over the fifth; to induce him to supply ten, the price must be 
sufficient to cover the cost of the tenth unit. 

The amounts of the supply schedule of an individual produc- 
ing under the law of increasing cost would be the maximum 
amounts he would offer at the given prices, and the prices, the 
minimum prices necessary to induce him to supply the given 
amounts. 

LAW OF INCREASING COST OR DIMINISHING RETURNS 

In agriculture and the extractive industries to a lesser degree, 
there is a tendency for commodities to be produced under the 
law of increasing cost. In the cultivation of a farm for ex- 
ample, a point is reached where an increase in product is ob- 
tained only at a more than proportionate increase in cost. This 
tendency is sometimes referred to as the law of diminishing re- 
turns, and may be stated as follows: In the cultivation of a 
given area of land or in the operation of a natural resource, 
after a certain point has been reached, increasing applications 
of labor and capital produce less than proportionate returns in 
product; provided no changes occur in the arts of production. 

It is immaterial whether we refer to this law as the law of 
increasing cost or diminishing returns, it is evident that if the 
unit return diminishes in proportion to the unit cost, the cost 
increases in proportion to the return. Buried deep in the nature 
of things, this law has reigned in agriculture since the time 
of Adam, but to Ricardo is given the credit of its first formal 
statement. 



182 PRACTICAL ECONOMICS 

EXPLANATION OF LAW; ITS LIMITATIONS 

In the earlier stages of the cultivation of a tract of land, 
increased applications of labor and capital, in the form of extra 
ploughing, harrowing, fertilizing, etc., may yield more than pro- 
portionate increases in product. After a time, however, extra 
doses of labor and capital will inevitably result in smaller and 
smaller returns, until the point is reached where the extra re- 
turn is just about equal to the additional dose of labor and 
capital. This point has been termed the margin of cultivation; 
the last dose of labor and capital the marginal dose, and the 
extra product just balancing it, the marginal return. 

We may state the same fact from the viewpomt of cost. Up 
to a certain point additional units of a product may be secured 
at a decreasing cost, after the point of minimum cost has been 
passed, additional units can only be obtained at an increased 
cost, and the point will finally be reached where an additional 
unit will cost as much to produce as it will bring in the market, 
this marks the terminus of profitable production. We may speak 
of it as the margin of production, the last unit as the marginal 
unit and its cost, marginal cost. 

Many rash and pessimistic predictions have been made from 
the time of Malthus to the present, by failure to realize the 
limitations of this law, the practical importance of which lies 
largely in its influence on the food supply of man. While the 
population of a country is ever increasing the amount of land 
from which foods can be procured is limited, and if this law 
is true, as the population increases, it can be fed only at an in- 
creasing cost. This was the fact that lent color to the Mal- 
thusian theory which so strongly agitated the British in the 
nineteenth century. The little proviso at the end of this law 
is important — "if no changes occur in the arts of production"— 
if the knowledge and equipment of the cultivator remained sta- 
tionary, then indeed there would be cause for alarm. 

We live, however, in a world of change and though agricul- 
ture did not awaken quite as soon as manufacturing to the power 
of the machine, or the magic of science, the last seventy years 
have witnessed a revolution in methods of providing men's tables 
with food. Better fertilizers, better methods of cultivation. 



INFLUENCE OF COST ON SUPPLY 183 

better grains and stock, through the efforts of Uncle Sam's 
scientists in the Department of Agriculture, and of men like 
Luther Burbank; the rapid and widespread utilization of ma- 
chinery, the latest example of which is the farm tractor of which 
180,000 were in use in 1918, all have tended to counteract the law 
of increasing cost. It has even been claimed that they have 
nullified it. Such, however, is not the case, for this law is 
rooted in the very nature of the universe, and though it may 
be and has been offset by other laws, it still remains in opera- 
tion, as every farmer knows. No matter how long improve- 
ments in the art of agriculture, due to invention. and discovery, 
postpone the point of diminishing returns to any piece of land, 
there comes a time, if more product is demanded, when it 
must be produced under the law of increasing cost. 
. In considering the effect of this law on the food supply of 
any one country, we must take into account the development of 
land and marine transportation, which has opened up a way of 
escape to the world's seven densely populated centers of civili- 
zation, from the otherwise inevitable action of this law in rais- 
ing the cost of food. As any one country exhausts its fertile 
soils, and gets into the condition of England in the early part 
of the nineteenth century, ocean transportation comes to the 
rescue, carrying food raised on the broad fertile plains of dis- 
tant lands, such as the Mississippi Valley, the Canadian North- 
west, Australia and the virgin plains on the banks of the LaPlata 
in Argentine. And who knows but that with the advance of 
aerial navigation, time and distance will be so commercially 
annihilated as to place the products of the most inaccessible 
places of the earth within a few hours' reach of the world's mar- 
kets, enabling our future centers of dense population to be fed 
with bread raised in the rich valley bottoms and plams of 
South Africa and other now remote places. 

INCREASING COST AND TOTAL SUPPLY PRICE 

The total supply price of any commodity produced under 
conditions of increasing cost will be based on the marginal cost 
of the marginal producer, whose supply is just necessary to 
satisfy the existing demand. 



184 PRACTICAL ECONOMICS 

The total supply is the sum total of the individual supplies. 
Among the individual producers will be some less favorably 
situated than others who, utilizing poorer land or forced to 
engage in more intensive cultivation, are producing at a higher 
cost; while others more fortunately situated are able to produce 
at a lower cost. A small amount might be supplied at a lower 
price, but if a larger quantity is demanded the price must be 
sufficient to induce the high cost producers to supply the neces- 
sary quantity. Those more fortunately situated will not sell 
at a lower price than their less fortunate competitors, and so 
will reap a larger profit. The one price at which the whole 
will sell will be based on the costs of the marginal producers, just 
as the price at which the individual will be willing to sell is 
based on his marginal cost. 

The sugar industry well illustrates the above principle. In 
the beet sugar industry of continental United States for instance, 
there are three well-defined areas of production, namely, the 
Pacific region with ten to thirteen factories in California and 
one in Oregon; the Mountain region including twenty-nine to 
forty-two factories in Colorado, Utah, Montana, Wyoming, 
Kansas, Nebraska, Nevada and Arizona; and the Eastern region 
with twenty-four to twenty-seven factories in States lying east 
of the Missouri River. The average costs of producing a ton 
of sugar for these areas in 1917-19 were as follows: 

Pacific, $96.64 per ton 
Mountain, $109.41 per ton 
Eastern, $135.20 per ton. 

The lower cost of production for the Pacific region is due 
primarily to the favorable climatic and soil conditions in Cali- 
fornia. And it is evident that if the price of beet sugar in the 
United States were to be based on th ecost of production in Cali- 
fornia, a large number of plants in the Mountain and Eastern 
regions would be forced to suspend operations. 

In stating our theory of the supply price of a commodity pro- 
duced under conditions of increasing cost we maintained it to 
be based on marginal cost; in actual practice, however, it is 
likely to be based on the marginal cost of 90 per cent of the 
supply, as is shown by the accompanying chart taken from the 



INFLUENCE OF COST ON SUPPLY . 185 

Report of the United States Tariff Commission on the Costs of 
Production in the sugar industry, from which we also take the 
following apt quotation bearing on this subject. 

Sugar production, it thus appears, is essentially an agricultural 
industry. Because of the varying degrees of fertility of land and vary- 
ing advantages of location with respect to market, costs are perma- 
nently higher in some regions, or on some sites, than in others. The 
land which is most fertile and most favorably located cannot supply 
the total quantity demanded. The price is high enough to make it 
pay to cultivate land less fertile or less favorably located. There are 
always producers of such a grade or in such a location that their profits 
are not more than average or normal, producers for whom production 
barely pays. These are the high cost producers, called, for brevity, 
the marginal producers. The producers more advantageously situ- 
ated continue to operate at low cost and receive the same price as the 
marginal producers; and they secure a larger profit. A study of the 
charts printed at the end of this report shows that in every locality and 
in every year the facts in the case of the sugar industry exemplify the 
results of the above analysis. There is a regular gradation of producers 
whose costs ascend like a flight of steps to the marginal producer. 
Further, there will always be in any given year a few producers who 
because of poor judgment, or drought, flood, flre, insect pests, or other 
misfortune will be shown as operating at a cost even higher than the 
marginal. Such a producer, for example, is obviously No. 68, Beet 
Sugar Industry, 1917-18 (Chart 111). His cost is $406.37 per ton. 
The average price of sugar for that year was only $120.40 per ton. He 
suffered a severe loss and clearly would not continue in business per- 
manently at the same cost. Economic forces are always tending to 
eliminate such producers as show, over a series of years, a cost above the 
marginal cost, but in any one year the vicissitudes of time and chance 
will throw a few individuals temporarily into this class. The class is 
permanent; the individuals in it change. 

INFLUENCE OF DECREASING COST ON INDIVIDUAL 
SUPPLY PRICE 

Many commodities are produced under conditions directly 
opposite to those referred to above; instead of the unit cost in- 
creasing with an increase in the supply, it decreases. In this 
case the unit price of any given amount will be based on the 
average cost to the producer, and the amount will be the small- 
est the producer will offer at any given price. 



186 PRACTICAL ECONOMICS 

As each of the preceding units have cost the producer more 
than the last, he will evidently be unwilling to sell them at a 
price based on the cost of the last. If the cost of the 1,000th 
unit was 50 cents and each of the previous units have cost more ; 
to sell the whole supply at 50 cents would entail a loss on every 
unit but the last. The producer must at least be assured of 
getting back his total cost, so that the lowest price he will 
be willing to supply any given number of units will be based, 
not on marginal cost, but on average cost. 

Another point of contrast between a supply produced under 
increasing and one produced under decreasing cost, is that 
while the amounts of the former are maximum, those of the latter 
are minimum amounts. The price at which the sellers operat- 
ing under decreasing cost, will supply a given amount is based 
on the average cost of production for that amount. Now as 
the average cost of a smaller quantity would be higher he would 
not be willing to suppty it at a price based on the cost of the 
larger quantity. At any given price, therefore, the amount is 
the minimum that will be supplied at that price, that amount 
or more will be offered. To sell merely the minimum at any 
given price just repays the bare cost of production, but to sell 
a larger quantity means an extra profit, and moreover, the larger 
the amount, the lower the cost, and the bigger the profit. Here 
the way to fame and fortune lies along the great highway 
of large scale production, and the individual producer labors 
under a powerful incentive to increase his sales, a fact, the 
significance of which will appear later. 

The supply schedule of a commodity produced under increas- 
ing cost is still further differentiated from one produced under 
decreasing cost, by the fact, that in the formei', prices vary 
directly with amounts, an increase of amount being accom- 
panied by an increase in price, whereas in the latter the opposite 
relation holds, an increase in amount being accompanied by a 
decrease in price. 

EXPLANATION OF LAW OF DECREASING COST 

Manufactured commodities are largely produced under the 
law of decreasing cost. Transportation is also a good example 



INFLUENCE OF COST ON SUPPLY 187 

of an industry operating under this law. While the law of in- 
creasing cost arises because of the part which nature inevitably 
plays in production, that of decreasing cost springs from man's 
activities. That the unit cost decreases as the volume of pro- 
duction increases, is due to the advantages of large scale organi- 
zation discussed in a previous chapter. An increased volume 
of production permits a more extensive use of machinery and 
a more profitable application of the principles of organization. 
These economies may be due directly to the increased efficiency 
of the individual organization or may arise indirectly as the 
result of large-scale organization in the industry as a whole or 
in its dependent industries. As an industry increases in size 
it will not only be able to produce more cheaply, due to the 
increased efficiency of its individual concerns, but will be en- 
abled to purchase its machinery and materials at a lower cost 
on account of this same principle reducing their cost as they in 
turn come to be made in large quantities. 

This law also has its limitations; there is a point in most 
industries beyond which increased production ceases to be ac- 
companied by decreasing cost; where the economies of large 
scale organizations are exhausted and further increase is carried 
on either at constant or increasing cost. The location of this 
point will vary in different industries depending on the nature 
of the particular industry, on the extent to which plant and 
machinery can be used and the economies of large-scale pro- 
duction be taken advantage of. In supplying a local community 
with electricity it may hold true for the whole supply. In the 
textile industry the limit is more quickly reached than in the 
steel industry. In each branch of production there is an estab- 
lishment of ideal size, in which the commodity is turned out 
at the lowest possible cost. In the realm of production effi- 
ciency sets bounds even to size. 

THE INFLUENCE OF DECREASING COST ON TOTAL 
SUPPLY PRICE 

If the total supply were to be produced by one concern operat- 
ing under decreasing cost, the lowest price at which they would 
supply any given amount would be determined by average cost. 



188 PRACTICAL ECONOMICS 

This would be a case of monopoly, however, and will be treated 
later. 

In any competitive industry wherein the supply is furnished 
by individual producers operating under the law of decreasing 
cost, the supply price will be based on the average costs of 
the marginal or high cost producers. Among the operating con- 
cerns will be some, more advantageously situated, more effi- 
ciently organized, with larger and better equipped plants operat- 
ing at a low cost; others less advantageously situated, less effi- 
cient, or smaller plants, with higher costs. These latter will 
not continue to supply the existing demand at a price below 
their cost of production. The more efficient, on the other hand, 
will no^ sell below their less efficient competitors, so that the 
whole supply will be sold at a price based on the cost of the 
producers at the margin. 

In an industry of decreasing cost, especially when cost des- 
cends rapidly, the individual producers being under a strong 
incentive to increased output, the supply tends to press on de- 
mand and occasionally outstrip it, provoking intense competi- 
tion, which is apt to force price below the cost of production 
of the marginal concerns, to the peril of their existence. We 
will discuss this situation later; for the present it is sufficient 
to emphasize the fact that in the case of a commodity produced 
under decreasing cost, the supply price will be based on the 
average cost of the marginal concerns whose supply is necessary 
to satisfy the existing demand, and that it decreases as the 
supply increases. Many of the commodities we enjoy today, 
from shoes to automobiles, could not possibly be sold for their 
present prices, were they not produced in large quantities. 

CONSTANT COST 

In some industries there is a tendency for cost to remain 
the same for a small or large output. The handicrafts oi 
medieval times operated on this principle, and such industries 
as cigar making by hand and custom tailoring, are modern ex- 
amples. There is also a tendency toward constant costs in some 
industries due to the counteracting influence of increasing and 
decreasing cost. 



PORTO i 




Explanation : 1 leasure costs in dollars per ton of sugar produced :- those ' 
to the ascending f ad by-products. Costs iaclude cane or beets, factory, 
marketing, deprec distance from the base hne to the upper ■ horizontal 
line measures the factory. (Facing page 188) > 



^120 
-§110 

:|ioo 

8 90 

■f 80 

c-70 

s- 

g. SO 
^ 50 
'fe 4.0 
I 2>0 





POffTO RICO, 1917-19/8 

Average New York Price 1318 
36 °centrifugals/l20.40 



J 120' 

-§ no 

■I 100 

I 90 

"g 80 

§- 70 

c 60 

^ 50 

*^ 40 

J 30 

V 20 

^ 10 

'% 





Y 








■ 








pi 












r 




" 






" 

































































































20 40 TO 

Ou+put 
in thousands of +onj. 

CUBA, 1917- 1918 

Average New York Price 1918, 



V ^^ ^...,,..ui/^.^ ~,^^.-r^ 



u 



so 100 150 180 
Output in thousands of tons 




200 300 

Output in thousands of fons- 

BEET SUGAR INDUSTR Y, 191 7-1918] Conhhenfa/ Urilf^dsfahs 

^ Awerage New York Price 1918- Granulated ^147.00 

Total Costs offer deductmg ■ 
Receipts ibr B^-Praductj 
Total Costs of Producing ■ \ 

Bath Sugar and Bg-Producfs 



20 40 60 80 
Output 
in thousands of tons 




300 400 

Output in thousands of tons 
Fig. 11. — CoBTS of Peodtjction in the Sugab Industry, 1917-18, Arranged bt^Factokibs 



Explanation : Horizontal measurements from in each figure (abscissas) show output in thousands of tons. Vertical lines (ordinates) measure costs in doUars per ton of sugar produced :■ those ■ 
to the ascending full line total costs after deducting receipts for by-products: those to the dotted line total costs of producing both sugar and by-products. Costs include cane of beets, factory, 
marketing, depreciation, taxes (except Federal income and excess profits), insurance, rent, overhead, but do not include interest. The distance from the base Une to the upper ■ horizontal ' 
line measures the average price per ton of sugar and the distance from the ascending full Mne to the price line shows ihe profit, factory by factory. {Facing page 188) ■ 



INFLUENCE OF COST ON SUPPLY 189 

INFLUENCE OF INCREASING AND DECREASING COSTS 

ON SUPPLY 

Many commodities are produced partly under conditions of 
increasing and partly under decreasing costs. In the sugar 
industry for example, the cane is grown on plantations operat- 
ing for the most part under increasing costs, whereas it is con- 
verted into sugar in factories under the law of decreasing cost. 
In the Hawaiian sugar industry for 1916-17, 42.2 per cent of 
the total cost of producing a ton of sugar was cane cost, while 
factory cost constituted 34.8 per cent of the total. The tendency 
toward decreasing cost in the manufacturing end of the 
Hawaiian sugar industry is shown in a striking manner by 
arranging the factories into three groups according to their 
size. The average cost per ton of sugar produced in the 13 
factories of smallest output was $37.13; that of the 13 of 
medium output $33.55, while the 13 largest had a cost of $33.79. 
In the Hawaiian sugar industry the percentage of raw material 
cost to factory cost is higher than in other centers of the sugar 
industry, but the influence of large scale production in the sugar 
industry as a whole may be seen by glancing at the chart which 
shows, as a general rule, the low cost producers to be the large 
producers; in all the figures the wide rectangles are to the left, 
growing narrower toward the right as they increase in height. 

The extent to which the price of the finished product will 
be influenced by either of these two opposing tendencies will 
depend on the relative proportions of raw materials to manu- 
facturing cost. In those industries such as the flour industry 
in which the raw material cost forms the major portion of the 
total, the law of increasing cost will dominate; in such indus- 
tries as watch-making in which the manufacturing cost predomi- 
nates, the law of decreasing cost will rule, with the result that 
the more popular the commodity becomes, the lower the price 
at which it may be enjoyed. 

In general these two laws, the one by increasing the cost of 
agricultural products, the other by reducing the cost of manu- 
factured goods, oppose each other in influencing the supply 
prices of finished commodities. A growing manufacturing na- 
tion can only escape the tendency toward rising prices for its 



190 PRACTICAL ECONOMICS 

raw materials, by importing them from newly opened lands 
in undeveloped countries. Thus did Great Britain by the repeal 
of her corn laws in 1846, open up a way of escape of her hard 
pressed population from high food prices by importing her food 
supply from Australia, Canada and the United States, and by 
her free trade policy has since been able to obtain the raw ma- 
terials for her manufacturers at much lower cost than she 
could have produced them herself even if that were possible. 
In this tendency we see revealed one of the great underlying 
causes of the territorial expansions of the older nations. 

SUMMARY 

Cost influences the supply prices of commodities by either in- 
creasing, decreasing or remaining constant, as the amount of 
their supply increases. 

The law of increasing cost operates in agriculture resulting 
in a tendency toward an increase in the supply price of agricul- 
tural products with an increase in the quantity supplied. 

The law of decreasing cost tends to reduce the supply price 
of manufactured commodities, as the volume of their produc- 
tion increases. 

In both cases the total supply price tends to be based on 
the cost of the producers at the margin, but under decreasing 
cost there is a tendency toward over-supply with price falling 
below marginal cost. 

TEST QUESTIONS 

1. In what three ways does cost influence supply? 

2. What unit of the supply determines the supply price of a commodity 
under the law of increasing cost? 

3. State the law of diminishing returns in reference to land. 

4. Explain the effects of this law on the cost of the food supply of a 
nation as time goes on and the population increases. 

5. What considerations must be taken into account in estimating the 
effects of the law? 

6. What will the unit cost be based on in the case of an individual pro- 
ducer operating under the law of decreasing cost? 

7. Explain the action of decreasing cost in an industry operating under 
the law of decreasing cost. 



INFLUENCE OF COST ON SUPPLY 191 

REFERENCES 

Bohm-Bawerk, E,, Positive Theory of Value (Book IV, Chap. VII). 

Cairnes, J. E., Character and Logical Method of Political Economy (Part 
I, Chap. III). 

Carey, M., Political Economy (Chaps. III-VII). 

Carver, T. N., Principles of Political Economy (Chap. XXIII), Distribu- 
tion (Chap. II). 

Clark, J. B., Essentials of Economic Theory (Chap. VII). 

Clay, H., Economics for the General Reader (Chap. XIV). 

Fetter, F. A., Economic Principles (Chap. VII). 

Friday, D., An Extension of Value Theory, Quarterly Journal of Economics, 
(Vol. 33, ff. 197-220). 

Flux, A. W., Principles (Chaps. IV, V). 

Hadley, a. T., Economics (Chap. III). 

Kester, R. B., Accounting. 

Marshall, A., Principles of Economics (Book IV). 

Nicholson, J. S., Principles of Political Economy (Chap. X). 

RiCARDO, D., Principles of Political Economy and Taxation (Chap. I). 

Sedgwick, H., Principles (1883, Book II, Chap. II). 

Smith, A., Wealth of Nations (Book Chap. VII). 

Taussig, F. W., Principles of Economics (Chaps. XII-XVI). 

Wicksteed, p. H., Common Sense in Pohtical Economy (Book I, 
Chap. IX). 

Wright, P. G., Value Theories Applied to Sugar Industry, Quarterly 
Journal of Economics (Vol. 30, p. 101). 

Federal Trade Commission Report on Meat Packing Industry, 1919. 



CHAPTER XVII 

INFLUENCE OF COST AND UTILITY ON PRICE 

RELATION OF DEMAND PRICE AND SUPPLY PRICE TO 
EQUILIBRIUM PRICE 

Now that we have completed our survey of the demand and 
supply sides of the market, we are in a position to see the real 
nature of, the equilibrium price. We saw before that the law of 
demand and supply tends to pick out a certain price, which as 
we said equates demand and supply, inasmuch as it is that price 
at which buyers and sellers are both willing to trade the same 
amount. In other words the interaction of demand and supply 
tends to pick out of the possible prices and amounts of the 
two schedules, the pairs that coincide. The equilibrium price is, 
therefore, the demand and supply price in one. 

As the demand price it is that price at which buyers will pur- 
chase the whole of the given supply. It is based on the utility 
of the commodity to the marginal buyers. 

As the supply price it is that price necessary to induce the 
sellers to supply the given amount, and is based on the cost 
of production of the marginal producers. 

These two brought together in one focal point constitute the 
equilibrium price; the one price at which the two contending 
parties en masse are brought into agreement at their respective 
margins. 

THE EQUILIBRIUM PRICE IN THE LIGHT OF THE 
FORCES WHICH DETERMINE IT 

When discussing the interaction of demand and supply we 
said it seemed as if two blind forces were forever seeking the 
price that would set them at rest. Whether above or below this 
point on the dial of value, prices always tend toward it, seem- 

192 



INFLUENCE OF COST AND UTILITY ON PRICE 193 

ingly impelled by some unseen force, as the steel needle of the 
compass is ever attracted to the north by the magnetism of 
the earth. We now see this actually to be the case; price move- 
ments are governed by forces coiled within the hearts of men, 
and the equilibrium price is in reality that price which is estab- 
lished by the balancing of the two opposing forces, desire and 
cost. 

It is at the margins of demand and supply that these two 
forces exert their influence. The demand price is governed by 
the utility of the commodity to the buyers at the margin, the 
supply price by the cost of production to the marginal producers. 
The equilibrium price is that which just balances the cost of the 
commodity to the marginal producer and its utility to the 
marginal consumer. 

Should the demand price be above the supply price it would 
hiean that the utility of the commodity to the marginal buyers, 
measured in terms of money, exceeds the cost to the marginal 
producers, measured also in money. This state of affairs in 
which the price is above the cost of the marginal producers will 
stimulate production, supply will increase and prices fall. 

Should the demand price be below the supply price it would 
signify that the utility of the commodity to the marginal con- 
sumers was less than the cost to the marginal producers. This 
condition will tend to discourage production, supply will decrease 
and prices rise. 

Only when demand and supply prices coincide are the two 
forces of desire and cost balanced. Any change in either de- 
mand or supply upsetting the balance of these two forces sets 
them in motion and their interaction will again tend to force 
prices to the equilibrium point. 

We are thus able to see behind the fluctuations of prices the 
forces that govern them; to see the reason for the statement 
of the business man that demand and supply determine prices. 
The equilibrium price is that price which desire and cost work- 
ing through the minds of buyers and sellers tends to establish. 
It represents desire and cost brought into harmony in terms of 
money. Back of all prices and price changes everywhere, are 
these two elemental forces. 



194 PRACTICAL ECONOMICS 

VARIATIONS FROM MARKET PRICES 

It is plain that the equilibrium point toward which the market 
price of a commodity sold under competitive conditions tends is 
not a fixed point. This could only be in a hypothetical state of 
society wherein there was no change. Furthermore, it should 
not be assumed that the law of supply and demand sets a 
rigid market price at which all sellers must and do dispose 
of their wares. This is very far from what actually occurs. 
An investigation of the market for almost any commodity will 
reveal considerable difference in the prices at which it is sold. 
While there will be a general or market price at which the bulk 
of the sales will be made, some concerns will be found selling 
above and others below, in the same market. The explanation 
of this is to be found in the leeway between the market price 
and the respective margins of cost and demand. 

The market price at any one time will tend to approximate 
the cost of the marginal producers on the one hand and the 
price of the marginal consumers on the other. The more effi- 
cient producers with lower costs could sell if they wished at a 
lower price. Whether they will do so or not will depend on their 
price policy. To sell below the market is often thought to be a 
mistaken policy, bringing only destructive competition and low- 
ered prices with little or no profit for any. Some new concerns, 
however, may sell below in order to secure sales and gain a 
foothold in an established industry. Some may do so in periods 
of depression to increase volume or because the lessened sales 
resistance allows of a less expensive method of selling. Other 
concerns prefer to sell at the market and secure their volume 
by intensive selling methods. Still others choose to sell above 
the market price. The market price is based on what will be 
paid by the least capable buyers at the margin of demand. 
There are many who would pay more and the sellers see to it 
that some of them do. This may be brought about by creating 
a belief in the minds of the buyers that the article is superior 
to that of their competitors or by using aggressive sales methods 
or it may be due to the inertia or indifference of buyers. 

These individual differences in prices are accounted for partly 



INFLUENCE OF COST AND UTILITY ON PRICE 195 

by the effects of the more farsighted sellers to adjust their 
prices to changes in the conditions of demand or supply. When 
costs increase as they did during the war some concerns will 
brave competition earlier than others by raising their prices 
and paving the way toward a higher market price. When 
scarcity in the supply and intensity of demand combine to make 
for a higher level of price as in the case of houses during the 
war and post-war period, some will take advantage of such a 
situation much sooner and to a greater extent than others and 
hasten the rise. When the tide changes and the demand begins 
to recede the cooler, shrewder heads who have been studying 
economic conditions quickly sense the change, lower their prices 
ahead of the crowd and connect with the new demand at the 
lower level. 

. If there be a sudden and drastic drop in demand, such as 
occurred in 1920, it may mean that the marginal demand price 
has dropped below the costs of the marginal producers who will 
be forced to lower their costs or be driven out of business. Many 
caught with stocks on hand, produced at the old high costs, were 
reluctant to sell them at a loss and held on hoping for a return 
of high prices. The consumer refused to buy at the existing 
high prices and demand continued falling. Those who analyzed 
the situation aright, who realized that the halcyon days of 
high prices were gone forever, got down to earth, quickly set 
about cutting their costs of operation, liquidated their high 
price stocks, and anticipated the inevitable fall in market prices 
by lowering the prices of their products below those of their 
competitors. This was not by any means an easy task especi- 
ally for the manufacturers who sold their products to the ulti- 
mate consumer through the middlemen. It was of little avail 
for the manufacturer to lower his price unless the wholesaler 
and retailer followed suit. The consumer still held off and the 
manufacturer had to beat time with his plant half closed down 
for lack of orders. This does not mean that all retailers refused 
to lower their prices and all manufacturers did. On the con- 
trary, many of the more progressive retailers being in closer 
contact with the buying public were among the first to sense 
the change, liquidated their high price stocks and brought what- 



196 PRACTICAL ECONOMICS 

ever pressure they could to force lower prices from reluctant 
manufacturers. But in many cases the small retailer not so 
well versed in economic conditions as the large manufacturer 
and loath to tear himself away from the easy ways and big 
profits which the post-war period had allowed him to indulge 
in, stuck to his old stock and prices. Situated as he was at the 
neck of the bottle of distribution, his sluggishness caused those 
manufacturers who did reduce their prices quite a problem. 

The bold action of the Interwoven Stocking Company in the 
early part of 1921 offers an interesting example of the manner in 
which some of the more progressive concerns successfully solved 
this problem and blazed a path to a newer and lower market 
price. The situation at the close of 1920 in the stocking industry 
was similar to that in many other lines. The bottom seemed 
to have dropped out of the market. The majority of factories 
were working at less than half capacity. The Interwoven people 
were convinced that the old high prices had gone forever and 
that prices were due to drop much lower. They believed that 
people would buy if the price were right, that there existed a 
demand at a lower price. They resolved to cut their prices 
to this level and avail themselves of the increased sales they 
had faith would be forthcoming. Moreover, they determined 
to do this at one bold strike, rather than by degrees. As Mr. 
Mettler, president of the company, put it:^ "We figured that 
if a dog's tail had to be cut off you can't save hurting the dog 
by cutting it off little by little! We knew that by April we 
would have to cut our prices practically in half. We decided 
to make the full cut at once, reducing our 75 cents (at retail) 
numbers to 40 cents, our $1.50 numbers to 75 cents and our $2 
line to $1.25." The reason was fully explained to the dealers 
and their cooperation secured. Three months was given them to 
get rid of their old stock before putting the new prices on the 
top tickets of the stocks. 

This drastic action on the part of the Interwoven Company 
involved the writing off of $1,156,000 of inventory at one stroke 
of the pen and also making a price below their then costs which 
were based on part-time cost of production. The new price was 

^Printers' Inh 



INFLUENCE OF COST AND UTILITY ON PRICE 197 

based on the lower costs of the anticipated full-time produc- 
tion that would accrue from the lowered price. The results fully 
justified their course for while most of their competitors were 
running on half time the Interwoven had one of the best years 
in its history. 

THE RELATIVE INFLUENCE OF UTILITY AND COST ON 

PRICES 

In years gone by some vigorous disputes have been waged 
as to which determined value; utility or cost? Ricardo was the 
great champion of the hosts of cost while Jevons stands as the 
most famous exponent of utility as the determinant of value. 
Thus did these two great men attack the truth from opposite 
sides and we of the present are indebted to them for our broader 
-viewpoint of the whole. Utility and cost act together in deter- 
mining price. To discriminate between them and say that either 
is the determinant is like saying that one side of a pair of scales 
determines the weight. There is a sense in which utility is 
said to be the more fundamental, as it is the cause for the ex- 
penditure of cost, it takes the initiative. Demand is the draft 
that draws the fires of industry; it invokes supply; because a 
commodity is wanted it is made, otherwise it would not be 
produced. But it is just as true that industry will not fur- 
nish a commodity without cost, any more than a fire will con- 
tinue to burn without fuel. The perennial argument as to which 
is the more important is in the main of academic interest. The 
question of practical import is: What is the relative power of 
the buyers and the sellers on price? And as this includes a 
view of the influence of both the forces at issue, we shall briefly 
discuss it pro and con. 

THE BUYER'S INFLUENCE ON PRICES 

To many, no doubt, it seems as though a chemical analysis 
would be required to find a trace of the buyer's influence on 
recent high prices; and this practically approximates the case 
with some commodities sold under conditions of combination 
or monopoly. In competitive selling, however, both buyers and 
sellers take a hand in settling price. It is quite true that sellers 



198 PRACTICAL ECONOMICS 

directly decide the price they will charge for their goods; the 
joker lies in the fact that the buyers decide the amount that will 
be sold. The sellers are in somewhat the same position in refer- 
ence to the buyers in the market as Artemus Ward to the spirits 
in the sea, "I can call the spirits from the windy deep," said 
he, "but damn 'em they won't come." The sellers may charge 
whatever they please, but they are scarcely able to drag the 
buyers into their stores and force a purchase. The prices set by 
the sellers are subject to the law of demand; the higher the 
price the smaller the quantity sold. In order to sell their whole 
supply they must adjust the price to suit the marginal buyers, 
whose purchases determine the amount that will be bought. 
The buyer's influence, though indirectly exercised, plays a very 
decisive part in price determination. 

In the interaction of demand and supply sometimes both are 
equally active in determining the price, sometimes either one 
may be the more active factor. In the case of a fixed supply 
with no reserve as to price, demand will be the active factor 
in settling the price. This has led to the statement that demand 
determines price. If one hundred units of a commodity were 
offered for sale on a market with no restriction as to price and 
the demand schedule showed that at a price of ten cents buyers 
were willing to purchase one hundred units, ten cents would be 
the highest price they would fetch. We might say, therefore, 
that the price was determined by demand; by the buyers. In 
so doing we take for granted the amount of the fixed supply, 
which had it been less would have resulted in a higher price, 
or more, in a lower. The amount of the supply being fixed, 
we ignore its influence and say that demand determines the price. 
Marshall, the English economist, has aptly likened demand and 
supply to the blades of a pair of scissors. If we hold one still 
we may say the cutting has been done by the other. In this 
sense only can we say that demand determines the price. 

In considering the relative influence of demand and supply 
on prices, time is an important factor. The shorter the period 
taken into consideration the greater the tendency toward a 
fixed supply, due to the fact that over a short period the supply 
is limited by the existing factors of production. Price will be 



INFLUENCE OF COST AND UTILITY ON PRICE 199 

at the mercy of demand; any sudden change in which will tend 
to raise or lower it. But given a period long enough to allow the 
factors of production to adjust themselves, supply will take a 
more active part in the price process by virtue of its control 
over the amount offered for sale. As a general rule the shorter 
the period of time, the more decisive will be the influence of 
demand. 

While it is always true that buyers and sellers both have 
a share in price determination, it is well worth while noting that 
sometimes the one, sometimes the other, holds the whip-hand. 

THE INFLUENCE OF SELLERS ON PRICES 

While it is self-evident that sellers cannot sell at any price 
they please, it is equally evident that buyers cannot buy at any 
price they please. Just as the selling price influences the 
amount that will be bought, so the price the buyers are willing 
to pay influences the amount they will be able to buy. In the 
same way as the sellers' prices are subject to the law of demand, 
the buyers' prices are subject to the laws of cost which govern the 
amount of the supply. The demand price for any given amount 
must be at least equal to the cost of the marginal producers, or 
they will not continue its production. In order to secure the 
amount they require, buyers must pay a price sufficient to induce 
the marginal producers to supply it. 

The power of the seller over prices is exerted through his 
control over the amount produced. Under perfectly free com- 
petition, that is in the absence of combination or monopoly, this 
control is exerted solely through the cost of production. The 
amount of the supply is limited by the cost of the marginal 
producers. The efficiency of this control in lixniting supply 
and maintaining price on an equality with marginal cost, de- 
pends on whether the commodity is produced under conditions 
of increasing or decreasing cost. 

RELATION OF COST TO SCARCITY AND VALUE 

We will digress here for a moment to notice with more exacti- 
tude the relation of cost to value. In discussing value we found 
two primary causes, scarcity and utility; in discussing the prices 



200 PRACTICAL ECONOMICS 

of the products of industry we have spoken of them as being 
determined by cost and utility. Is cost then a third cause of 
value on a plane with scarcity and utility? 

The products of industry by very definition involve cost, 
which is the chief factor limiting their supply. In this they 
differ from natural products the supply of which is limited by 
nature. The values of both are directly determined by utility 
and scarcity, but in the case of industrial products cost enters 
the scene as a special cause of their scarcity. It bears the 
same relation to value as labor, the position of which we dis- 
cussed on page 121. The cost of production theory of value 
is an outgrowth of the labor theory, both are supported by much 
the sam,e arguments, both may be shown inadequate as explana- 
tions of value for the same reasons. Cost is a secondary cause 
of value, acting always through scarcity which with utility deter- 
mines the value of everything. The vital part which cost plays 
as the cause of the scarcity, as the regulator of the supply of 
the products of industry sold under competition, justifies, how- 
ever, the emphasis placed upon it. 

THE INFLUENCE OF DECREASING COST ON 
EQUILIBRIUM PRICE 

In those industries in which the individual producers are 
operating under decreasing costs, there is a tendency to instabil- 
ity on the part of the equilibrium price. 

Should the actual price be above the equilibrium, it would 
mean a price above marginal cost; this would stimulate pro- 
duction and price would fall. The ominous feature about price 
under decreasing cost, however, is that it is possessed of a ten- 
dency not to stop at the equilibrium but to keep on falling. 

The equilibrium price of such a commodity it will be re- 
called, is based on the minimum output of the marginal pro- 
ducers. The temptation of larger profits from the lower cost 
of a larger output will be a constant stimulus to them as well 
as to the rest of the producers in the trade who are operating 
under decreasing cost to forge ahead and increase their volume 
of production. Supply thus spurred on will overtake demand 
and price will tend to fall. 



INFLUENCE OF COST AND UTILITY ON PRICE 201 

Under increasing cost, if the price fell below the equilibrium 
and thus below marginal cost, the only course open to the mar- 
ginal producers was to cut cost by reducing output; cost thus 
automatically reduced supply and the price rose. Under con- 
ditions of decreasing cost the situation is reversed. The way 
of escape to lower cost lies in the direction of increased volume. 
Cost thus acts to increase supply even when price is below the 
costs of the marginal producers. 

This state of affairs leads to cut-throat competition. Some of 
the marginal producers in order to sell a larger volume at a 
lower cost will cut the price. Others must follow. As prices 
sink the weaker concerns are forced out of business. The large 
and efficient concerns and those able to make the changes neces- 
sary for volume production survive. For a while the supply 
may be reduced and price go up, but as long as any of the 
producers are operating under decreasing cost, supply will con- 
tinue to press on demand and price will tend to fall below 
cost. Should the industry be one in which the point of de- 
creasing cost is soon reached and is followed by increasing cost, 
this tendency will cease. 

RESULTING TREND TOWARD COMBINATION OR 
MONOPOLY 

If the industry is one of large-scale production the course of 
evolution will inevitably set toward combination or monopoly, 
either by peaceful combination, or along the warpath of com- 
petition with its struggle for existence and survival of the fittest; 
or by both methods, as illustrated by events in the steel indus- 
try during the nineties. Uncontrolled competition in an in- 
dustry of decreasing cost means cut-throat competition, rate 
wars, price below cost, an intense struggle for existence on the 
part of the marginal concerns with their elimination or absorp- 
tion by their bigger competitors. The sole avenue of escape 
from the drastic action of demand and supply under decreasing 
cost is for the producers to regulate the supply by combined 
action. Here free competition ceases and combination begins. 

If the looser forms of combination such as mere understand- 
ings arrived at through manufacturers' associations, gentlemen's 



202 PRACTICAL ECONOMICS 

agreements and pools, are declared illegal or fail to accomplish 
their purpose, competition if given free rein will eventually 
destroy itself and evolve into combination or monopoly. A 
state of cut-throat competition and rate war, is never permanent; 
men get tired of the strain and strife. If carried to the bitter 
end such a struggle results either in the formation of some 
powerful monopolistic organization, able by virtue of its con- 
trol over the supply to stabilize the price, as does the United 
States Steel Corporation the price of steel, or in the formation of 
several large concerns which by intercourse through trade asso- 
ciations are able to cooperate instead of compete in the regula- 
tion of supply. 

Uncoptrolled competition, then, tends to be replaced by some 
form of combination not only on account of a desire to escape 
the drastic consequences of the law of demand and supply under 
decreasing costs, but by the dual benefits to be derived on the 
one hand from the economies of large-scale organization, and on 
the other from the power over price which combination gives 
to the producers. The crux of the whole price question lies in 
the extent to which the producers are able to control the price 
by virtue of their ability to regulate the supply through com- 
bination or monopoly. 

SUMMARY 

The law of demand and supply is based on the interaction 
of the two forces, desire and cost. The equilibrium price is sim- 
ply the price which these forces tend to establish when left to 
work themselves out under conditions of free competition. It is 
that price which the free bargaining of buyers and sellers tends 
to fix, which brings them both into agreement, being equal to 
the costs of the marginal producers on the supply side and the 
utility of the commodity to the marginal buyers on the demand 
side. 

In the case of a commodity produced under conditions of de- 
creasing cost, there is a tendency for price to fall below marginal 
cost, due to the instability of supply and its tendency to overtake 
demand. Cost fails to limit the supply. Producers have thus 
been forced by the pressure of circumstances to combine for 



INFLUENCE OF COST AND UTILITY ON PRICE 203 

their own protection. Uncontrolled competition which means 
unregulated supply has thus been replaced by combination 
which means regulated supply. The question which remains to 
be answered relates to the nature and extent of the control 
over price by combination and monopoly. 

TEST QUESTIONS 

1. What is meant by '"'demand price"? "Supply price?" "Equilibrium 
price?" 

2. What two forces determine the equilibrium price of a competitive 
market ? 

3. Under conditions of competition what influence do buyers have on 
prices? 

4. How is the control of the seller exerted on price under competition? 

5. Explain the tendency toward combination in an industry of decreas- 
ing cost. 

REFERENCES 

Cairnes, J. E., Character and Logical Method of Political Economy (Part 
I, Chaps. II-IV). 

Clark, J. B., Essentials of Economic Theory (Chaps. III-VI). 

Clay, H., Economics for the General Reader (Chaps. XIV and XV). 

Ely, R. T., Outlines of Economics (Chaps. X and XI). 

Green, D. I., Pain Cost and Opportunity Cost (Quarterly Journal of Eco- 
nomics, VIII, 1895) . 

HoBSON, J. A., Economics of Distribution (Chap. II). 

Laughlin, J. L., Pohtical Economy (Chapter XV). 

Marshall, A., Principles of Economics (Book V). 

Seligman, E. R. a., Principles of Economics (Chaps. XII-XVII). 

Smith, A., Wealth of Nations (Book I, Chaps. V-VIII). 

Taussig, F. W., Principles of Economics. 

Walsh, C. M., Measurement of Exchange Value (Chap. I). 



CHAPTER XVIII 

THE INFLUENCE OF MONOPOLY ON PRICE 

NATURE OF MONOPOLY 

Thus far in our study of the action of the law of demand and 
supply in determining price we have assumed that there is no 
concerted action on the part of buyers or sellers to control either 
the demand or the supply. Any control of either interferes with 
the free action of the law. Free and open competition implies 
independent action, all absence of agreement, on the part of 
buyers or sellers. Monopoly as the term is usually employed, 
implies a control over the supply by the sellers. Just as soon as 
competing producers are able by joint action to control supply 
and influence price monopoly power begins. Such control ranges 
from the indefinite yet effective regulation brought about by an 
understanding between competitors, to complete control over the 
whole supply by one sole producer. The central idea of monop- 
oly is unified action in the control of supply. It is usually de- 
fined as such a control over the supply of a commodity as to 
enable the seller to fix the price. 

MONOPOLISTIC CONTROL ARISING THROUGH BUSINESS 
ASSOCIATIONS 

The loosest form of united action on the part of competing 
sellers arises from their association in trade organizations of 
various kinds. The number of such associations is legion. They 
exist in every branch of industry from farming to retailing. 
There are associations of lumbermen, dairymen, and produce- 
men, milk distributors, iron and steel producers, shoe manufac- 
turers, clothiers, bankers, bakers, grocers, credit men, and so 
on, local, national, and international. 

Their purpose is to promote and protect the interest of their 
respective trade or profession. They gather and disseminate 

204 



THE INFLUENCE OF MONOPOLY ON PRICE 205 

information of common value and discuss questions of common 
interest; and in this connection, of course, prices are by no 
means taboo. 

An interesting example of such association is seen in the 
asbestos business, in which there are three organizations, the 
Asbestos Textile Manufacturers' Association, organized in 1915; 
the Asbestos Paper Manufacturers' Association, and the Asbes- 
tos Brake Lining Manufacturers' Association, organized in 1916. 
These have the same secretary and work on the same lines. 
They are loosely formed on advice of counsel, confirmed by a 
representative of the Federal Trade Commission; they have no 
constitution or by-laws, but are based upon a declaration of 
principles covered in the minutes of the first meeting as follows: 
''It was decided to organize a permanent association, for the 
purpose of standardizing methods of manufacture, methods of 
cost finding, and for the purpose of distributing among the mem- 
bers all information as to quotations, contracts, and actual bona 
fide sales which might lawfully and justly be published." The 
secretary states that '*'no effort is made to fix or control prices or 
in any other manner to stifle or influence trade. The whole 
object of the association is to place before each member at 
periodical intervals concise and accurate information as to the 
tendencies of supply and demand, prices, production, and so 
forth." This is an example of what is termed the "Open Price 
Idea" in association work. The secretary further states that 
before the organization of the association many of the men were 
competing each with the other without even being personally 
acquainted. Now that they meet monthly, old-time jealousies, 
suspicions and disagreements have disappeared and in their 
place have sprung up good feeling, mutual reliance and harmony 
of action; "general conditions have been so improved that you 
could not find a member who would for a moment consider giving 
up the Cooperative Competition Idea." 

There is not a shadow of a doubt but that such organizations 
are a benefit to their members, and are also productive 
of much good to their respective trades and to industry as a 
whole. There is also no doubt but that such organizations afford 
an opportunity for concerted action on the part of sellers in con- 



206 PRACTICAL ECONOMICS 

trolling supply and regulating price. That such association, by 
which free-for-all competition is replaced by cooperative com- 
petition may give rise to understandings and agreements regard- 
ing price and place in the hands of the sellers a certain monop- 
olistic power is well illustrated by events in the newsprint paper 
industry during the war when the balance between the supply 
of and the demand for paper was uncomfortably close. The 
Federal Trade Commission after a most careful investiga- 
tion of that industry states in its report issued on March 3, 
1917, that: 

By means of a trade association, organized ostensibly for a lawful 
purpose, conditions in the. market were influenced in a very substantial 
degree, knd in a manner which sustained a price which would not be 
possible under conditions of free competition. Concert of action was 
made possible through this association in the matter of discouraging 
new production of newsprint paper, in the division of customers, in 
the promotion of fear that the supply would not be equal to the de- 
mand, in disseminating propaganda justifying higher prices because of 
alleged higher costs, and in other ways. The increase in the prices 
charged are not justified by the increased costs of production. 

The idea of cooperative competition is sound; it is the natural 
child of changed industrial conditions; it is supplanting indi- 
vidualistic competition throughout the whole of industry and 
rightly so. It should be clearly understood, however, that such 
cooperation on the part of sellers, places in their hands a power 
over price that does not exist under free-for-all competition, a 
power which by virtue of its very subtlety is by no means uni- 
versally recognized, but which is perhaps more far-reaching in 
its effect on prices than that of the big monopolist who looms 
up more conspicuously in the popular mind and is on that ac- 
count the more likely to be curbed. 

SPECIFIC AGREEMENTS AND POOLS 

Closely akin to the unity of action by competitors arising from 
business association is that springing more directly from alli- 
ances formed for the distinct purpose of influencing prices. These 
alliances range from mere meetings of competitors with little or 
no special machinery for the execution of their purpose, such as 



THE INFLUENCE OF MONOPOLY ON PRICE 207 

the famous Gary dinners, to the loose form of organization 
known as the pool. The form of agreement may be a mere 
understanding in regard to price, a "gentleman's agreement," or 
a formal contract involving a restriction of output, a division of 
territory, price fixing or division of profits. The testimony of 
Charles M. Schwab before the Industrial Commission is illum- 
inating in regard to the extent of such practices. When asked if 
there had been pooling agreements in the steel industry he re- 
plied: "Yes, in all lines of business, not only in steel but in every- 
thing else. There were similar agreements, known as joint agree- 
ments to maintain prices. They have existed in all lines of 
business as long as I can remember." 

The name, pool, has been used indiscriminately to apply to all 
forms of united action by competitors for the purpose of con- 
trolling supply or influencing price; strictly speaking, however, 
a pool involves the placing of a part of the receipts or profits 
into a common fund to be distributed among the members by 
agreement. The pool first came into prominence among the 
railroads, which adopted this method of joint action to prevent 
rate cutting and stifle competition. They have existed in manu- 
facturing industries since 1860, though the great era of the pool 
proper was from 1870-1887. Railroad pools are illegal, and in 
manufacturing pooling agreements have usually been held to be 
contracts in restraint of trade and therefore against public 
policy. They are an unstable form of organization, their weak- 
ness lying in the fact that their contracts being unenforceable by 
law, it is hard to hold the contracting parties in line. 

Pools and agreements in spite of their weakness and their dis- 
favor in the eyes of the law have played an effective part in price 
control and, contrary to the opinion of some writers who treat 
them as relics of a by-gone age, they still flourish in great 
variety, especially in their more elusive forms. The recent report 
of the Federal Trade Commission on the meat packing industry 
reveals some interesting facts in this connection. It appears the 
first pool in that industry was brought to light through an inves- 
tigation by a United States Senate committee, which in 1890 
reported that there was an agreement between the then leading 
packers to refrain from competition; that there was collusion 



208 PRACTICAL ECONOMICS 

with regard to fixing of prices, division of territory and business. 
These conditions were partly responsible for the passage of the 
Sherman Act in 1890. In 1912 it was admitted by Henry Veeder 
under oath that from May, 1893, to May, 1896, representatives of 
the leading packers met regularly every Tuesday afternoon in a 
suite of rooms leased in the name of Henry Veeder, who acted as 
secretary and statistician. At these meetings the territory was 
divided and the volume of business to be done by each packer 
was apportioned upon the basis of statistics compiled by Veeder, 
penalties being levied when any one of them exceeded his allot- 
ment. This "Veeder pool" was followed by other pools and sup- 
plemented by a policy of concentration and combination by the 
big paqkers, who absorbed many of the strong independents. As 
fast as one pool was broken or rendered impolitic by a govern- 
ment investigation another was formed. According to the com- 
mission,^ there exists today a live stock pool which 

is not only an automatic regulator of the relative volume of business 
of each of the big five, but also secures substantial uniformity of prices 
paid for live stock and consequently the prices at which dressed meats 
are sold. In brief the prearranged division of live stock purchases 
forms the essential basis of a system by which the big packers are 
relieved of all fear of each other's competition, and, acting together 
are able to determine, not only what the live stock producers shall 
receive for their cattle and hogs but what the consumer shall pay for 
his meat. 

SELLING ORGANIZATIONS 

Somewhat similar to the pool is the selling organization, 
formed by a number of competing producers for the purpose of 
marketing their joint product. This is a more compact form of 
organization very common in Germany but by no means rare 
in the United States. The best known examples are perhaps the 
fruit growers' exchanges. The stockholders of the exchange are 
the growers; the exchange acts as a selling agency, charging 
commission for its services. A good example of such an organi- 
zation is the California Fruit Growers' Association, a non-profit 

^ Summary of the Report of Fed. Trade Comm. on Meat Packing 
Industry. 



THE INFLUENCE OF MONOPOLY ON PRICE 209 

corporation under the laws of California, acting as a selling 
agency for over 6,500 fruit growers, who are organized into 115 
local associations, each of which has its packing house where 
the fruit is assembled, pooled and packed for shipment. These 
local associations ship their fruit through seventeen district 
exchanges, which act under the direction of a central exchange. 
The central exchange is managed by a board of seven directors 
acting through a general manager. It looks after all matters 
relating to the selling of the fruit, has agents in all the prin- 
cipal markets of the states and Canada, secures information rela- 
tive to the demand, conducts extensive advertising campaigns, 
and develops new markets. 

These organizations are a good example of cooperative com- 
petition where cooperation was needed. Speaking generally, the 
farmers and growers have been slower to organize than the manu- 
facturers or the middlemen to whom they sell, which has placed 
them at a disadvantage and resulted in their often being forced 
to sell at prices which have not brought them a fair return for 
their efforts. The Cooperative Marketing Association has en- 
abled them to get their product more directly to the jobbers and 
grocers and to eliminate speculation. They have improved con- 
ditions and through their advertising have established brands, 
thus giving the public the assurance of standard quality. There 
is no doubt that they eliminate competition and influence prices, 
— stabilize them would be the better word. In fixing prices they 
must of necessity pay considerable attention to demand, which is 
elastic in the case of fruit. So far their injEiuence has been bene- 
ficial to the producer and not harmful to the consumer, but in 
view of the rapid increase in these associations during the last 
five years, the fact should not be lost sight of that each is re- 
placing free competition by an organized control over the supply 
of a commodity by virtue of which it is able to wield a power- 
ful influence over price. 

COMBINATION 

The various forms of organizations discussed so far have been 
loose in form and more or less ephemeral, while the fact that the 
united parties still retained their autonomy as producers, afforded 



210 PRACTICAL ECONOMICS 

only an incomplete control over the supply; hence a more stable 
form, insuring a firmer grasp over supply, was sought. The 
famous "trust" was first tried, a union of separate corporations, 
each of which transferred its stock to a group of trustees who 
then controlled the constituent companies. The trust being de- 
clared illegal, the holding company was devised, which achieved 
the same purpose. The merger followed later. These two, which 
we have already described, secure perfect control over the con- 
stituent companies and complete unity of action. The extent of 
monopoly power wielded by one of these organizations will de- 
pend largely on the percentage of the supply of the whole in- 
dustry controlled by it. The American Sugar Refining Company 
in 1892 controlled 90 per cent of the entire sugar refining busi- 
ness of the country. The whisky combination has controlled as 
high as 90 per cent of the entire production of spirits. The 
United States Steel Corporation in 1901 controlled about 60 per 
cent of the iron ore supply of the United States and about 65 per 
cent of the country's steel production, which percentage has been 
since reduced. 

The degree of monopolistic control is not confined to the 
amount of output directly controlled by any one combination, 
but is reinforced by the ease with which a few combinations in 
any one industry can cooperate in the ways illustrated among 
themselves or with small independents. In the salmon packing 
industry for example, five ' groups of companies control 51 per 
cent of the entire output and set the price at which the great ma- 
jority of the packers dispose of their product. The ''Big Five" 
in the meat packing industry are said to control ^ 70 per cent of 
the live stock slaughtered by all packers and butchers engaged 
in interstate commerce. 

DEGREES AND FORMS OF MONOPOLY CONTROL 

In this analysis of the means by which unity of action is secured 
by competing producers in the control of supply and price, we 
have passed from the indirect to the direct, the loose to the com- 
pact, the incomplete to the complete. It has been a journey from 

' Report of Fed. Trade Comm. on Canned Goods, Dec, 1918. 

^ Report of Fed. Trade Comm. on Meat Packing Industry, July 5, 1918. 



THE INFLUENCE OF MONOPOLY ON PRICE 



211 



competition to monopoly along the road of cooperation and 
combination. We have not attempted any elaborate or detailed 
account of the forms and extent of monopoly which is beyond 
our present aim, but sufficient has been said at least to suggest 
the presence and extent of monopolistic agencies in our industrial 
society and to give some idea of their nature. All monopolies 
do not by any means evolve out of competition; some spring 
direct from government grants, as patents, copyrights and fran- 
chises, which confer on the owner the sole right for a period to 
produce. Closely related to these is the private brand, a preva- 
lent and powerful form of monopolistic control backed up by 
advertising. 

MONOPOLY POWER OVER PRICE ILLUSTRATED 

. The essence of monopoly is power to regulate supply so as to 
fix price. This is illustrated in the diagram Fig. 12. The demand 



Y 

r.1 


'\ 


Ml 






P' 










\ 




^^S 


P 






Xci-^-^^ 






^ 






^^^^ 


N 


|\ 




S 






i ^ 





M 



C 

Fig. 12 



and supply curves SS and DD indicate that under competitive 
conditions the amount OC would be produced at the price CC. 
The rising supply curve indicates that the commodity is produced 
under the law of increasing cost, the one price at which the whole 
would sell being based on the cost of the marginal producers. 
The combined profits of the competitive producers are measured 
by the triangular area PC'S. 

Should the producers get together in such a way as to be able 
to control the supply, they would be enabled to command a 
higher price under the same conditions of demand. By restrict- 



212 



PRACTICAL ECONOMICS 



ing the amount of the supply to OM they could command the 
price MM\ This they might accomplish by raising the price to 
MM', which would enable them to dispose of OM units of the 
commodity at a profit represented by the area P'M'NS. 

LAW OF MONOPOLY PRICE 

Monopoly price, therefore, will not necessarily be based on 
marginal cost, but will be that price which will bring the largest 
profit to the seller or the sellers. The amount sold under 
monopoly will not be limited automatically by marginal cost as 
under competition, but by virtue of the control over supply en- 
joyed by the monopolist, it will be the amount that will bring 
him the most profit. 

UNDER DECREASING COST 

In the case of a commodity produced under decreasing cost, 
the monopolist in order to fix the price that will bring him the 
most profit must bear in mind that the higher the price, the 
fewer the sales, the higher the unit cost: and conversely the lower 
the price, the bigger the volume of sales, the lower the unit 
cost. He will seek by estimate or experiment that price which 
will bring him the largest net profit. In so doing he will keep 
his eye on gross receipts and total cost, the difference between 
which measure his gain. The following table illustrates such 
a case; under the assumed conditions the monopolist would de- 
rive the largest profit by selling the commodity at ten cents. 



Unit 


Number 


Unit 


Gross 


Total 


Profit 


Price 


of Sales 


Cost 


Receipts 


Cost 




$.50 


100,000 


15 


$50,000 


$15,000 


$35,000 


30 


170,000 


12 


59,500 


20,400 


39,100 


25 


300,000 


10 


75,000 


30,000 


45,000 


15 


800,000 


7 


120,000 


56,000 


64,000 


12 


1,500,000 


5 


180,000 


75,000 


105,000 


10 


3,000,000 


4H 


300,000 


135,000 


165,000 


8 


4,000,000 


4J^ 


320,000 


170,000 


150,000 


5 


8,000,000 


4 


400,000 


320,000 


80,000 



THE INFLUENCE OF MONOPOLY ON PRICE 213 

TAPPING SEVERAL STRATA OF DEMAND 

It is sometimes stated by economists that monopolists are able 
to sell their product at different prices while under competition 
the whole supply must be sold at one price. Theoretically this 
may be possible but in practice it is not common. The illustra- 
tion is sometimes given of a branded good such as soap, being 
sold at several prices ; a standard grade being put out at 10 cents ; 
a price of 25 cents being charged for the same soap, with a dash 
of perfume, and a colored wrapper marked ''Superfine." In such 
a case it is not the same product, however slight the difference 
may be, but a different grade of product ; and in competition dif- 
ferent grades fetch different prices even when these grades are 
purely imaginary, as in the case of grocers who have been 
known to sell coffee from the same bag at different prices by 
putting it in different bins marked at 18 cents, 25 cents and 35 
cents. 

It is, however, a common practice for monopolists to differen- 
tiate their product, as in the case of a branded good, and to 
sell at different prices by tapping several separate layers of 
demand, thus increasing their volume of sales and materially 
adding to their profits. To stick to our soap illustration, there 
is a large body of consumers who will not pay more than ten 
cents for a cake of soap. There is a second class of people per- 
fectly willing to pay 25 cents for their favorite toilet article and 
still a fastidious third class, connoisseurs in soap as it were, who 
will blithely pay 50 cents for a perfumed artistically wrapped 
creation, wi^ a smack of distinction. In other words there 
are several strata of demand for soap, and this is true of most 
products from condensed milk to automobiles. 

MONOPOLY POWER AND DEMAND 

Monopoly power over price is much influenced by the condi- 
tions of demand. In general the more elastic the demand the 
more careful must the monopolist be in fixing the price ; the more 
inelastic the demand the greater will be his power over the 
price. 

In the case of a commodity sensitive to price changes, a slight 
rise in the price will be followed by a big cut in sales; on the 



214 PRACTICAL ECONOMICS 

other hand a large increase in the volume of sales will be se- 
cured by a small reduction in price. As a rule it will not pay 
the monopolist to restrict unduly the supply of a commodity 
with an elastic demand; such restriction will make little differ- 
ence in the price he will be able to get. If he is manufacturing 
a commodity subject to decreasing cost it will be to his interest 
to increase the supply, which he can do without being forced 
to lower price to any great extent. In this situation "it pays 
to advertise," a fact which monopolists are coming to realize 
much to their advantage. 

For a commodity with an inelastic supply the conditions are 
reversed. The monopolist will be able to raise his price without 
much f^ar of curtailing his sales, while they will not increase 
to any great extent much if he lowers price. A restriction of the 
supply will now make possible a big increase in price, while on 
the other hand an increase of supply would cause a big drop in 
price. Here, then, there will be every inducement for the 
monopolist to limit output and raise price. 

Conditions of inelastic demand offer a tempting field to the 
monopolist and furnish a rich harvest of monopoly profit. In 
the case of the necessities of life, such commodities as bread, 
coal, light and heat, and local transportation, especially where 
there are no available substitutes, the monopolist may have the 
consumer at his mercy and wield a dangerous power. 

LIMITATIONS TO MONOPOLY POWER 

In our discussion of monopoly price we said that it was the 
price which would bring the monopolist the largest profit. This 
statement, to be correctly understood, needs to be qualified. 
Should the monopolist enjoy a complete control over supply 
it will be possible for him to fix the price calculated to bring 
the biggest profit. In actual practice, however, good business 
policy will usually dictate a more conservative course, because 
of the fear of three things, namely, competition, substitution and 
government control. 

Excessive profits in any branch of industry attract capital 
and invite competition just as surely as sugar draws flies. Re- 
cent history shows that even in those industries, dominated by 



THE INFLUENCE OF MONOPOLY ON PRICE 215 

the most powerful combines, competition is by no means dead 
even if denatured. The history of the sugar, whisky and steel 
industries demonstrates this. High prices also irritate the con- 
sumer and encourage substitution and there are few articles for 
which there are absolutely no substitutes. Finally, exorbitant 
prices attract the lightning of Governmental legislation. A lower 
price than the highest price acts as insurance against these 
hereditary foes of monopoly, and for purely business reasons 
it will usually pay the monopolist to adopt a policy of wise 
restraint. The United States Steel Corporation is a shining ex- 
ample of a concern which has followed such a course since its 
organization. Properly amended the law will read that monop- 
oly price is that price which in the long run will bring the monop- 
olist the maximum profit. 

MONOPOLY PRICE USUALLY HIGH PRICE 

To say that monopoly always results in exorbitant prices 
would be an exaggeration of the facts. It is perfectly possible 
for monopoly price to be below competitive price, owing to the 
economies that may be attained by placing production under 
the control of one concern, as in the case of a local gas or elec- 
tric supply. It may also be in the interest of the monopoly to 
set the price at a low figure as for instance when decreasing cost 
governs the production of a commodity the demand for which 
is elastic. Or the monopolist may have the interest of the pub- 
lic at heart and set as low a price as is consistent with a fair 
profit to himself. Making full allowance for these possibilities 
it is patent that as a general rule, the price of a commodity 
produced under conditions of monopoly will be higher than for 
that same commodity under conditions of free competition. 

This is but a common-sense conclusion. There is no question 
of the power over price which monopoly brings. The history 
of competition is nothing but a history of the continuous striv- 
ing after this power by fair means or foul. Ever since the 
Laissez Faire period of the nineteenth century there has been 
evidenced in commerce a constant and irrepressible trend toward 
monopoly power. 

Moreover, the verdict of history is that monopoly price is 



216 PRACTICAL ECONOMICS 

high price; it has at times meant exorbitant price as with the 
government monopolies of medieval England. Unbiased stu- 
dents of modern monopoly such as the late Van Hise, pronounce 
it to be higher than competitive price. A study of the evidence 
presented by the most exhaustive investigation of recent times, 
that made by the Industrial Commission appointed by Congress 
in 1898, into the nature of industrial combinations and their 
effect, cannot fail to lead an impartial observer to the conclusion 
that such combinations have had the effect of raising the prices 
of the commodities they control to a higher point, than would 
have been the case under competition. More recent investiga- 
tions reinforce this conclusion and give some glaring instances 
of the abuse of this power. 

TEST QUESTIONS 

1. What is the root idea of monopoly? 

2. Explain the monopolistic effect on price of business associations. 

3. What is a "pool"? What is the object of a pool or "gentleman's 
agreement"? 

4. How might a "selling organization" exert a monopolistic influence 
on the price of a commoditj^? 

5. What is the law of monopolj^ price? 

6. What are the three limitations to monopoly power? 

7. Is monopoly price necessarily the highest price? 



CHAPTER XIX 

COMPETITIVE PRICE; MONOPOLY PRICE; PRICE 

REGULATION AND THE LAW OF 

DEMAND AND SUPPLY 

THE LAW OF DEMAND AND SUPPLY UNDER 
COMPETITION 

Our study of prices has involved a study of the law of demand 
and supply, with its twin underlying forces, desire and cost, 
from whose interaction the law derives its power. In order to 
gain a clear view of the nature of the law we first noticed its 
operation under conditions of perfectly free competition, — ideal 
conditions, which allow the free interaction of the underlying 
forces. Under such conditions an equilibrium price would be 
established, based on marginal cost and the utility to the mar- 
ginal consumer. 

But in actual life competition is never perfectly free. In our 
modern industrial system, the inequality of competitors, the im- 
mobility of the factors of production, particularly the high 
degree of specialization in labor and capital, interfere with free- 
dom of motion and clog the wheels of competition. There is 
always friction in the practical operation of all forces, whether 
mechanical or human. Hence in stating the law of price under 
actual competitive conditions, we said that prices tend toward 
an equilibrium price. We have used the term tendency all 
through our explanation. When dealing with human forces it 
is, of course, impossible to measure them with the exactitude 
we have assumed, for instance, in the demand and supply sched- 
ules. But to make clear the action of the forces utility and cost, 
in determining price it is necessary to use definite figures. It 
should not be thought, however, that because these forces are 
incapable of exact measurement they do not work accord- 
ing to law. They most certainly do, and the tendencies we have 

217 



218 PRACTICAL ECONOMICS 

presented show the action of the law as it operates under condi- 
tions of ordinary competition, unhampered and free from any 
manipulation. 

THE LAW OF DEMAND AND SUPPLY AND MONOPOLY 

PRICE 

In studying monopoly price we find the same law, the same 
forces, but now operating under different conditions. Under 
conditions in which the forces on one side are organized and 
on the other unorganized. Monopoly is such a control of the 
supply side of the law as enables the monopolist to manipu- 
late the law to suit himself. Monopoly is simply manipulation 
of the law of demand and supply by one of the interested parties. 

It is often said in reference to the failure of competition to 
establish a fair price that "business is conducted in opposition 
to economic laws," meaning the law of demand and supply. A 
statement due, perhaps, to the over-emphasis which economists 
have sometimes given to this law under ideal conditions. The 
fact of the matter is that business today is conducted very much 
in accordance with the law of demand and supply. The law 
of demand and supply is buried deep in human nature and must 
always be reckoned with. It can, however, be regulated and 
controlled. And all the monopolist is doing is to control the 
law for his own benefit. Here lies the gist of the whole mat- 
ter. All human achievements come by working in harmony 
with natural laws. The monopolist is wise in his day and gen- 
eration, and just as he has by control of physical laws increased 
the product of his plants, so by his use of the law of demand 
and supply he has been able to increase the price of those 
products in the market. 

It is equally possible for the manipulation to take place on 
the buyer's side by the control of demand. It has been said 
that "the husbandman has always been the dupe of the law 
of demand and supply." Here we have the reason; the farmer 
has heretofore played the game single handed; he has furnished 
the supply under conditions of individualistic competition for 
an organized demand. By means of the cooperative marketing 
association, he is fighting fire with fire. Both sides being organ- 



COMPETITIVE PRICE: MONOPOLY PRICE 219 

ized a better equilibrium will be established and a fairer price 
obtained. 

In the evidence gathered by the Industrial Commission be- 
fore referred to, the power of the big combination to influence 
price by virtue of its control over demand was clearly shown. 
When any company secures a monopoly of the manufacture of 
a commodity it has the producers of the raw material pretty 
much in its power and is liable to leave them little profit. This 
is exactly what the ''Big Five" in the meat packing industry 
are accused of by the Federal Trade Commission; of combined 
action in purchasing by means of which they are enabled to 
control the price of live stock. They ^ kill 70 per cent of the 
live stock slaughtered by all packers and butchers engaged in 
interstate commerce. The commission stated: 
. ^Thus without any collusion beyond agreement to divide purchases, 
the price which the producer receives for his live stock is bound in the 
long run to be the lowest price which will keep the producers raising 
cattle, hogs and sheep and sending them to the stock yard. 

Here we have an example of a double-actioned monopoly 
standing midway between the- producers of the raw material 
on the one side, and the ultimate consumers on the other. It 
gets them going and coming as it were, and is enabled by its 
control of demand on the one side and supply on the other, to 
depress the price of cattle and to raise the price of meat. Of 
course it may not use this power ; in fact it is vigorously denying 
it in an extensive and expensive advertising campaign to the 
public. The point that requires emphasis is the powerful possi- 
bility afforded by such a monopolistic position, which denotes 
the very acme of monopoly efficiency. 

THE UNORGANIZED, ULTIMATE CONSUMER 

If the structure of our present industrial system has in some 
cases rendered competition passe, and in others undesirable; if 
cooperation and combination are essential for productive effi- 
ciency; and if such a situation inevitably means that the prices 
of many commodities are no longer governed by the free action 
of the good old law of demand and supply, as that law is gener- 

^ Summary Report of Fed. Trade Comm. Meat Packing Industry, p. 11. 
2 Summary Report of Fed. Trade Comm. Meat Packing Industry, p. 25. 



220 PRACTICAL ECONOMICS 

ally understood by the public, but by the manipulation of that 
law by one of the interested parties who thereby yields a power 
over price that places the consuming public at his mercy; some 
regulation of that monopolistic power would seem absolutely 
essential for the protection of the unorganized, ultimate con- 
sumer. The importance of a low price to the consumer is seldom 
realized, while his interests at stake are to say the least, any- 
thing but zealously guarded. It is too often a case of what is 
everybody's business is nobody's business. 

THE LAW OF DEMAND AND SUPPLY AND "A FAIR AND 
REASONABLE PRICE" 

We are brought face to face with the old question of a fair 
and reasonable price ; fair to the producer, reasonable to the con- 
sumer. Competition in many cases fails to establish such a price 
and when competition is superseded by monopoly we have a 
prejudiced price, in this lies the weakness as well as the menace 
of monopoly price. Nothing so unfits a judge for his office as a 
personal interest in the case. The intense personal interest of 
the monopolist in the price over which he has the power, some- 
what unfits him to be the judge in the case; his decision is 
apt to be biased. By its very nature monopoly price is not a 
fair price and moreover it has proved itself in many instances 
to be a very unfair price; hence, it has seemed desirable and in 
many cases absolutely necessary for the welfare of the con- 
sumer to take this mandatory power over price out of the hands 
of the monopolist, and vest it with some unbiased third party 
to ensure fair play to both producer and consumer. 

THE LAW OF DEMAND AND SUPPLY AND 
GOVERNMENTAL PRICE CONTROL 

Governmental regulation of price does not involve the sub- 
stitution of any new law of price. Any regulation of price must 
take into consideration the law of demand and supply and to 
be successful must work in harmony with it. Should the price 
be fixed too high, many consumers will be deprived of the com- 
modity and demand will fall off. At the same time the high 
price will stimulate production and increase supply as under 



COMPETITIVE PRICE: MONOPOLY PRICE 221 

competition, or monopoly. Should the price be fixed too low, 
demand will increase, but production will be discouraged and 
supply fall off. The price must be fixed in accordance with the 
law of demand and supply. Both the cost of production and 
the extent and intensity of consumer desire must be taken into 
consideration. Such a price must afford a fair profit to the 
marginal producers above their cost of production, and enable 
the marginal consumer to satisfy his wants at a reasonable 
figure. Here is where the accountants will come into the lime- 
light, for price fixing necessitates an accurate knowledge of costs, 
the standardization of cost methods, and accessibility of cost 
information to the proper parties. Even a greater publicity re- 
garding cost will go a long way toward insuring fair prices. 

Government price control simply means regulation of the law 
of demand and supply by means of price control. There is 
nothing impractical or chimerical about it; it is already in suc- 
cessful operation in some fields, notably in the case of public 
utilities. An extension of it to many commodities, whose prices 
are still fondly believed to be determined by the unmanipulated 
law of demand and supply under competition would in all likeli- 
hood result in lower prices to consumers and still leave a fair 
profit for the sellers. 

THE THREE PRICES 

1. Competitive Price. — Under conditions of competition prices 
of commodities tend by the interaction of demand and supply to 
correspond with the cost of the marginal producers and the 
utility to the marginal consumers. 

2. Monopoly Price. — Under monopolistic conditions, by the 
manipulation of the law of demand and supply, the prices of 
commodities are those which in the long run bring the most 
profit to the monopolist. 

3. Price by Government Regulation. — Under conditions of 
either competition, cooperation, or combination, by intelligent 
and impartial governmental regulation of the law of demand and 
supply through price control, the prices of commodities will be 
based on the cost of production plus a fair profit to the marginal 
producers, and their utility to the marginal consumers ; insuring 



222 PRACTICAL ECONOMICS 

an adequate supply of those commodities wanted by the public 
at a price fair to the producer and reasonable to the consumer. 
It should be noted that governmental price regulation does 
not interfere with private initiative, or threaten the freedom 
of the agents of production, in which case it would be un- 
desirable. Its function is not to curtail freedom but preserve 
it by a wise control. It can be applied alike to conditions of 
either competition, cooperation, or large-scale organzation which 
it does not aim to abolish but to control for the public benefit. 

TEST QUESTIONS 

1. Explain monopoly as a manipulation of the law of supply and 
demand. ' 

2. What is a "buyers' monopoly"? 

3. What is the relation of the ultimate consumer to the law of supply 
and demand? 

4. Why is not monopoly price likely to be a "fair and reasonable" price? 

5. What is the danger of arbitrary price fixing? 

6. What is a "fair and reasonable" price? 

REFERENCES 

CoMPTON, W., Price Problem in Lumber Industry American Economic Re- 
view, Vol. 7, p. 582). 

Duncan, C. S., Marketing, Its Problems and Methods. 

Ely, R. T., Outlines of Economics (Chap. XII). 

Fetter, F. A., Economic Principles. 

HiGHAM, C. F., Scientific Distribution. 

Jenks, J. W., The Trust Problem. 

LiTMAN, S., Price Control During the World War. 

Marshall, A., Principles of Economics (Book V), Industry and Trade. 

Nystrom, p. H., The Economics of Retailing. 

Seager, H. R., Principles of Political Economy (Chap. XIII). 

Shaw, A. W., Some Problems in Market Distribution. 

Simpson, K., Price Theories, Quarterly Journal oj Economics, Vol 35, 
p. 2S7. 

Taussig, F. W., Principles of Economics (XII-XVI), Price Fixing, Quar- 
terly Journal of Economics (February, 1918, p. 240). 

Tosdal, H. R., Open Price Associations, American Economic Review 
(Vol. 7, p. 331). 

Van Hise, C. R., Concentration and Control. 

Weld, L. D. H., The Marketing of Farm Products. 

WiCKSTEED, P. H. The Common Sense of Political Economy (Chaps. V- 
VIII). 

Wyman, B., Control of the Market. 



CHAPTER XX 

MONEY 
MONEY AND WEALTH 

No discussion of exchange and value would be complete with- 
out some explanation of the one thing by means of which today 
all exchanges are effected and in terms of which all values are 
expressed. 

It has been truly said that, ''Our society is built with money 
for mortar; money is present in every joint of circumstances; 
it might be named the social atmosphere, since in society it is on 
that alone that men continue to live and only through that or 
chance that they can reach or affect one another." There is 
scarcely a want of civilized man but depends directly or indi- 
rectly on money for its fulfillment. It is the universal medium 
between desire and satisfaction; the golden master key of civili- 
zation, without which we may shiver, starve, or perish in the 
midst of plenty, possessing which all the rich stores of society's 
treasure troves lie at our disposal. 

So closely allied to wealth is money that in the minds of many 
the two are synonymous. From serving as a means to wealth, 
money has become the symbol of wealth, and as a symbol it has 
usurped the place of the wealth it symbolizes; the idol has be- 
come the god. In like manner, because capital goods are valued 
in terms of money and are obtainable only in return for money, 
in the minds of millions whose eyes fail to pierce beneath the 
surface, money constitutes the capital wealth of the country. 
This commercial idolatry of money distorts the truth in two 
ways; first, by exaggerating the importance of money, second, 
by ignoring the real nature of the service it performs. In this 
chapter we will examine the nature of money and the part it 
plays in exchange. 

223 



224 PRACTICAL ECONOMICS 

WHAT MONEY REALLY IS 

Modern society produces its commodities under a system of 
division of labor; division of labor necessitates exchange; ex- 
change brings up the problem of value; exchange is facilitated 
and value simplified by the use of money. 

Without exchange division of labor would be impossible, and 
without money, exchange to the extent it is carried on today 
would be impractiable. Through the instrumentality of money 
society effects the myriad of exchanges on which its well-being 
depends. 

Money, then, is in reality a tool; its use is to facilitate the 
exchange of commodities and services. It is a capital good, just 
as the l6comotive is a capital good; and like the locomotive, it 
serves to transfer commodities from one place or person to 
another. The simplest and truest conception of money is that 
of a tool, the purpose of which is to effect the exchanges neces- 
sary in modern society for the production and distribution of 
wealth. 

THE FUNCTIONS OF MONEY 

First and foremost, money acts as a medium of exchange. It 
is perhaps best defined as that thing which is generally accept- 
able as a medium of exchange and as a final payment for debt. 
Acting as a medium of exchange, it has become a standard of 
value. These are its two primary functions. As a result of these 
it also serves as a standard of deferred payments and a store of 
value, the former being particularly important in these days of 
long-time contracts. Such are the chief offices performed by 
money in its capacity as a tool for facilitating exchange. 

QUALITIES OF GOOD MONEY 

To perform these functions efficiently, that which is to serve 
as money should be generally acceptable, stable in value, port- 
able, readily recognizable, easily divisible, homogeneous, and 
durable. 

Of necessity anything to become a medium of exchange must 
be generally acceptable. Tobacco, wampum, beads, or gold, each 
owed its election to the office of money first and foremost to its 



MONEY 225 

being an object of general desire. The one reason why every 
man is not only wiUmg but anxious to exchange his particular 
products or service for money is because he knows that everyone 
else who has products for exchange is likewise willing to accept 
money in lieu of them. Just as soon as a commodity loses this 
quality of general acceptability its usefulness as money ceases. 
This may happen even though it be issued by the government 
and declared legal tender for debt, as in the case of the green- 
backs during the Civil War, which did not circulate as money 
in California for the simple reason that they were not acceptable 
to the people of that state, who preferred and used gold as 
money. The fundamental quality of a good money is general 
acceptability. 

While theoretically it is not necessary that a commodity to 
serve as money should possess a value of its own apart from its 
use as money, in practice it has been found expedient to choose 
as money some commodity possessing a value independent of its 
monetary use. Pure paper money termed 'Tiat Money," owing 
its value entirely to governmental decree and control over the 
supply, may serve as money, as did the greenbacks from the time 
of the Civil War to 1879. Such money, however, has seldom 
proved satisfactory, and the monetary experience of nations has 
shown time and time again that to be generally acceptable 
money should possess value in the world at large, a value of its 
own apart from its use as money. 

Not only so, but it is highly essential, since money acts as a 
standard of value and of deferred payments, that its own value 
should not fluctuate. Stability of value is a prerequisite of 
paramount importance in the commodity that is to serve as 
money. 

THE SURVIVAL OF THE FITTEST 

It is easy to see why, of the many commodities that have 
served as money, the precious metals alone have survived and 
why, of these two, gold has almost ousted silver from the field. 
Gold is of universal acceptability; it possesses value all the 
world over outside of its use as money, being highly prized for 
its beauty in the arts, much desired as a mark of social distinc- 



226 PRACTICAL ECONOMICS 

tion, besides being in demand for more utilitarian purposes, such 
as dentistry. It possesses stability of value in a high degree, 
it is portable, easily recognized, and therefore not easily counter- 
feited. Unlike its predecessors, tobacco and wheat, it is of 
one grade. There is tobacco and tobacco, but gold is gold the 
world over. Lastly, it embodies value in about as imperishable a 
form as is possible; it will neither burn like paper, spoil like 
wheat, nor crush like a shell; an English gold sovereign, it has 
been estimated, would take eight thousand years to wear out. 

THE RELATION OF THE GOVERNMENT TO MONEY 

While in ancient times or in new communities a commodity 
might come into use as a medium of exchange of its own accord 
and maintain its position by habit or custom, as did iron and 
copper among the ancients and wampum and tobacco among the 
American colonists, the right of issue and control of the money 
supply early became the prerogative of the monarch or govern- 
ment, and among modern nations the selection and regulation 
of money and the monetary system has become one of the most 
important of government functions. 

This does not imply that money becomes money merely by 
virtue of government decree, or that the government is able to 
make anything money. As just explained, a commodity to serve 
as money must first be generally acceptable to the people; the 
sanction of the government clinches that acceptability; not only 
so, but it is doubtful, owing to the dangers surrounding the issue 
of money, whether a money whose issue was not controlled and 
safeguarded by the government would be generally acceptable to 
the people at large. 

So vital is money to the welfare of the nation, so essential to 
the smooth running of the industrial system, which, based on 
division of labor, demands above all things the free and unhin- 
dered circulation of products finished or unfinished through the 
arteries of commerce, that it has been found wise to place the 
tools and machinery on which this all at bottom depends under 
the control of the government. 

Hence in all modern nations the government chooses, regulates, 
and controls by law the money and the monetary system. The 



MONEY 227 

■ state selects the commodity that is to serve as money, decides on 
the quantity of it that will constitute the monetary unit, the 
different coins into which it shall be coined, takes charge of the 
minting of these, declares them full legal tender for debt, which 
means that they must be accepted by creditors as legal payment 
for all debts expressed in terms of money. Thus the state pro- 
tects the contract of exchange, one of the most common as well 
as important of all contracts. In addition, it supplements this 
standard money with other forms, decides on the extent to which 
they are to be legal tender, and regulates their supply according 
to the needs of trade. 

ADOPTING A STANDARD 

In selecting a commodity to serve as its medium of exchange 
■and standard of value, a country is said to "adopt a standard." 
Thus it is said that, "in 1816 Great Britain adopted the gold 
standards and that most countries since then have gone on a 
gold basis." Each country has decided that a certain weight 
of gold, to which it gives a name, shall constitute its standard 
unit of value, just as the French government decided that the 
cubic centimeter of water should constitute its unit of weight, 
termed a gram. Great Britain decided that its standard of 
value should be the sovereign and defined it as consisting of 
123.27447 grains (7.98805 grains) of English standard gold or 
113.0015 grains pure gold. The United States calls its unit of 
value the dollar and defines it as consisting of 25.8 grains of gold 
nine-tenths fine. In the same manner the Franc of France and 
,the Mark of Germany signify certain weights of gold officially 
adopted by those countries as their standard units of value. 

COINAGE 

In olden times the precious metals were actually weighed, and 
a pair of scales was part of a merchant's equipment. The names 
of many coins are in fact derived from the weights of the 
metals they once represented. The shekel, the talent, the mark, 
the franc, the pound, were all originally names of weights. The 
English "pound" sterling is derived from the Saxon pound of 
silver, the ancient standard of value of that sturdy race. 



228 PRACTICAL ECONOMICS 

Later, the pieces of metal came to be stamped by the govern- 
ment, which saved the trouble of weighing and certified them to 
be of correct weight and of the proper fineness. Thus we have 
the coin which is in reality an ingot, the weight and fineness of 
which is certified by means of some manner of design, imprinted 
on its surface. The English sovereign, for instance, is a gold 
ingot stamped and guaranteed by the English government to 
contain 123.2744 grains of gold eleven-twelfths fine. 

It is not even necessary that the standard unit itself should 
be made into a coin; it may serve merely as the basic unit of 
those coins which are issued. In the United States, for instance, 
no one dollar gold pieces are minted, and have not been since 
1890, but the gold pieces that are coined are multiples of the 
dollar or unit, the ten dollar gold piece containing exactly ten 
times 25.8 grains of standard gold. Coinage today is simply a 
legal device for dividing the standard money metal into con- 
venient units of certified weight and fineness. 

FREE COINAGE 

While in olden times, the Seignior or Monarch made a hand- 
some profit out of coining, called Seigniorage, most governments 
today make no profit; in fact many make no charge for the 
expense of coinage termed Brassage, but require merely a 
nominal fee for assaying and for the alloy used. This charge is 
so small that for all practical purposes we may say that most 
nations on a gold standard coin all gold brought to them free of 
charge. The United States, for example, stands ready to receive 
all gold bullion brought to its mints, returning to the bearers 
weight for weight of gold dollars. 

STANDARD MONEY 

These coins are known as "standard money" in distinction 
from all other media of exchange of general acceptability which 
may be passing from hand to hand as money. For though a 
country adopts a certain weight of gold to be its standard unit 
of value and final medium of exchange, and issues it in the form 



MONEY 229 

of coins, it supplements this standard money by other media of 
exchange of general acceptability, all of which are multiples 
or sub-multiples of the standard unit, and all of which are con- 
vertible finally into standard money. 

In the strictest sense a country on a gold standard has but one 
kind of money, namely, gold; all other media of exchange only 
partially perform the functions of money, all derive their value, 
and general acceptability from the fact that they are finally 
exchangeable for gold. This is the essential feature of the whole 
system; this is what is meant when it is said that a country is 
on a "gold basis." Apparently there are in each country several 
kinds of money, each as generally acceptable as a medium of 
exchange, in fact preferably acceptable to gold. The fact of 
the matter is that all these other media of exchange are only 
acceptable so long as they themselves are exchangeable for the 
the real medium gold. Let this convertibility be once doubted, 
and their acceptibility and value will shrink like a pricked 
balloon. The naked truth is that gold alone is money in the 
strictest and fullest sense and all other media of exchange which 
pass as money within the country are simply representatives or 
auxiliary means of rendering gold more efficient. 

In any country on a gold standard, gold coin is known as 
standard money. Such money is the actual embodiment of the 
weight of gold officially selected to serve as the standard unit 
of value and final medium of exchange, all other money issued is 
expressed in terms of it or comparable to it and is finally con- 
vertible into it. 

SUPPLEMENTARY OR AUXILIARY MONEY 

All other media of exchange of general acceptability, issued 
by the government or by banks under government supervision, 
act to conserve and augment gold, and may be termed supple- 
mentary or auxiliary money. 

Such money may be classified under three heads: (1) Bullion 
Certificates; (2) Government or Bank Notes; (3) Token Money. 

Bullion certificates, such as the United States gold certificates, 
are analogous to warehouse receipts certifying that a specified 



230 PRACTICAL ECONOMICS 

amount of gold is deposited in the government vaults; they save 
wear and tear on gold and being more convenient are preferred 
in the great majority of transactions within the country to the 
gold coin itself to which the owners of the notes are entitled. 

Government notes or bank notes are promises to pay standard 
money on demand. In Europe they are issued by banks; in the 
United States by both the government and banks. Their con- 
vertibility into gold is secured by a reserve of standard money; 
not a cent for cent reserve as with United States gold cer- 
tificates, but one which will be ample to redeem all of the notes 
that are likely to be presented at any one time. As experience 
has demonstrated that but a fraction of the notes will ever be 
presented' for redemption at one time, a large volume of notes 
may be issued against a comparatively small reserve of gold. 
Such notes are not only a substitute for gold but materially 
augment and increase the efficiency of gold, every gold dollar 
or sovereign in the vaults, having several notes or bills repre- 
senting it in actual circulation. 

Token money includes the various subsidiary coins of baser 
metal issued by every country to supply its need for small 
change. The value of the metal in such coins is less than their 
nominal value: they serve as very convenient tokens of incon- 
veniently small amounts of gold. They are issued by the gov- 
ernment in limited quantities according to the requirements of 
trade and are also convertible into gold. 

There is probably no other one thing which the average citizen 
of the United States desires more and knows less about than the 
money of his country. For the sake of better acquaintance, 
we will briefly describe the various members of our monetary 
family. 

MONEY OF THE UNITED STATES 

The following table taken from the report of the Secretary of 
the Treasury for the fiscal year ending June 30, 1921, lists the 
ten different kinds of money with their respective amounts/ 
which constitute the monetary stock of the United States. 



MONEY 



231 



Kinds 

Gold coin and bullion, 
Silver dollars, 
Subsidiary silver, 

Total metallic. 
United States notes. 
Federal Reserve notes. 
Federal Reserve bank 
notes. 
National bank notes, 

Total notes. 
Aggregate metallic and 
notes, 

Gold certificates. 
Silver certificates, 
' Treasury notes of 1890, 

Aggregate, 



In Treasury, 

Mints and Fed. 

Reserve Banks 

2,342,714,808 

213,735,045 

9,663,502 



In Circulation Total Stock 



883,404,285 

73,053,333 

261,650,873 



3,226,119,093 

288,788,378 
271,314,375 



2,566,113,355 1,220,108,491 3,783,221,846 



4,031,479 
319,935,586 

2,422,848 
13,739,861 



342,649,537 
2,680,494,274 

148,349,552 
729,550,513 



346,681,016 
3,000,429,860 

150,772,400 
743,290,374 



340,129,774 3,901,043,876 4,241,173,650 



2,906,243,129 5,121,152,367 8,027,395,496 



343,674,220 
1,044,470 



452,174,709 

201,534,213 

1,576,184 



5,776,437,473 8,027,395,496 



GOLD COIN AND BULLION 

Of the $8,027 million which constituted the monetary stock of 
the United States, at the close of the fiscal year 1921, over $3,226 
millions consisted of gold coin and bullion. During the last 
forty years the country's stock of gold money has increased by 
leaps and bounds: in 1879 it was 245 million dollars, in 1900 it 
had grown to a billion, in 1910 to over a billion and a half, in 
1916 to almost two billion and a half, while today it exceeds 
three billion and constitutes about one-third of the gold 
monetary stock of the world. 

Less than half of this stock of gold is in the form of coins. 
The gold coinage of the United States consists of quarter eagles 
($21/2) half eagles ($5) eagles ($10) double eagles ($20), which 
are full legal tender for all debts public and private. The bullion 
referred to in the report consists of bars of gold, assayed of speci- 
fied weight and stamped, which are more convenient than coin 
for export purposes and for reserves in the vaults. 

More than one-half of this gold coin and bullion is in the 
possession of the government, part being held in the Treasury 



232 PRACTICAL ECONOMICS 

in trust for Gold Certificates, part serving as reserve in the 
Treasury or Federal Reserve Banks, part belonging to the free 
fund of the United States Treasury.. The remaining $883 million 
said to be "in circulation" serves for the most part as a reserve 
in the vaults of banks throughout the country. 

GOLD CERTIFICATES 

The Secretary of the Treasury is authorized to receive gold 
coin or bullion and to issue in exchange for the same, gold cer- 
tificates in denominations of from $10 to $10,000. The net 
amount of such certificates outstanding June 30, 1918, was 
$1,026,631,669. The gold deposited for such certificates is held 
in trust in the treasury vaults, and may be claimed at any time 
by the owners of the certificates, which are but a convenient 
means of circulating this gold. These certificates are legal tender, 
are receivable by the government for all public dues, and may 
be counted by banks as part of their lawful reserve. 

SILVER DOLLARS 

The enormous stock of silver dollars in the possession of the 
United States is a heritage from the past, resulting mainly from 
the large supplies of silver purchased under the Bland Allison 
Act of 1878 and the Sherman Act of 1890. By the Pittman 
Act of April 23, 1918, which authorized the Secretary of the 
Treasury .to melt and sell as bullion not in excess of 350 million 
standard silver dollars, the supply was temporarily reduced by 
$68,453,583, making the stock of silver dollars at the close of 
the fiscal year 1918, $499,515,930, of which but 77 million were 
in circulation, the remainder being held in the treasury. In 1921 
the silver coins increased in volume by $32,390,020. The silver 
dollar contains 371^/4 grs. of silver, the value of which is con- 
siderably less than a dollar. While these silver dollars are not 
directly redeemable in gold, it has always been the policy of 
the government to so redeem them and the act of 1900 which 
instructs the Secretary of the Treasury to maintain all forms 
of money at a parity with gold, insures their redemption in gold 
beyond question, and establishes them as token money with 
their value based on gold. They are full legal tender for all 



MONEY 233 

payments public and private except for interest on government 
bonds, 

SILVER CERTIFICATES 

Few of these clumsy silver dollars are in actual use, their 
circulation is secured by means of silver certificates, similar in 
nature and purpose to the gold certificates. These are issued 
for the most part in small denominations and have become the 
popular pocketbook money of the nation. They are not legal 
tender, but are receivable by the government in payment of all 
public dues and may be counted by banks as part of their 
lawful reserves. 

TREASURY NOTES 

' The Treasury notes originated from the Sherman Act of 1890, 
156 million being issued by the government to pay for the silver 
purchased under that Act. Each note represents so much silver 
stored in the Treasury vaults. They are redeemable in either 
silver or gold and when so redeemed are cancelled, and if re- 
deemed in gold, silver certificates are issued in their stead. These 
$1,576,184 notes are the sole survivors of a form of money that 
will soon become extinct. Treasury notes are legal tender ex- 
cept in payment of principal and interest of government bonds, 
and lawful money for bank reserves. 

SUBSIDIARY SILVER AND MINOR COINS 

Half dollars, quarters and dimes are coined by the govern- 
ment as the country needs them, and are shipped in exchange for 
other kinds of money or paid out over the counter, in the 
Treasury offices. The government of course makes a seigniorage 
on this coinage which in 1918 amounted to over thirteen million 
dollars. These coins are redeemable in lawful money and are 
legal tender for payments not exceeding $10.00. 

Minor coins, one cent pieces, and nickels, not mentioned in 
the report, are also coined and distributed in the same manner 
as subsidiary silver and are in great demand. They are re- 
deemable in lawful money when presented in sums or multiples 
of $20. Over 81 million dollars worth of these humble but hard- 



234 PRACTICAL ECONOMICS 

working members of the monetary family were outstanding June 
30, 1918. 

UNITED STATES NOTES (OR "GREENBACKS") 

These were first issued by the government during the Civil 
War. The largest amount outstanding at any one time was 
$449,338,902 in 1864. By various acts of Congress authorizing 
the cancellation of these notes, the amount outstanding has been 
reduced to $346,681,016. This process of retirement was ar- 
rested by the Act of Congress of May 31, 1878, which ordered 
all redeemed notes to be reissued, and the outstanding amount 
has remained the same ever since. When first issued the coun- 
try had suspended specie payments, so that these notes were to 
all intents and purposes Fiat Money pure and simple. By the 
Resumption Act of 1875, the Secretary of the Treasury was 
ordered to redeem these "promises to pay" in coin: by the Act 
of March 14, 1900, a special gold reserve of $150,000,000 was 
ordered set aside by the redemption of these and the remaining 
Treasury notes. They are issued in denominations as low as 
$1 and $2 but the majority are in the form of $5 and $10 bills. 
They are legal tender except for the payment of principal and 
interest of the public debt. 

NATIONAL BANK NOTES 

These also date back to the Civil War. The National Banking 
System established in 1863 had as its twofold object, the market- 
ing of government bonds, and the supplying of a safe and uni- 
form national currency to replace the varied and insecure issues 
of the state banks. Any National Bank may issue these notes, 
the law requiring that such bank deposit with the Secretary of 
the Treasury government bonds of equal par value beside which 
each bank must deposit in the Treasury as a redemption fund, 
an amount of lawful money equal to five per cent of its note 
issue. These notes are redeemable on demand in lawful money 
both at the bank of issue and at the Treasury. They are neither 
legal tender nor lawful money, that is, they cannot be counted 
by banks as part of their reserves; they are receivable for all 
public dues, except duties on imports and may be paid out by 



MONEY 235 

the government for all debts and demands except interest on 
the public debt and for redemption of the national currency. 

FEDERAL RESERVE BANK NOTES 

Very similar to the National Bank Note is the Federal Reserve 
Bank Note created by the passage of the Federal Reserve Act 
of December 23, 1913. This act contemplated the retirement of 
the National Bank Notes and their replacement by similar notes 
issued by the Federal Reserve Banks. The National Banks are 
not forced, but may if they so desire, retire their notes within a 
period of twenty years dating from December 23, 1913, by filing 
an application with the Secretary of the Treasury to sell their 
bonds held by him in trust; which bonds may be bought by the 
Federal Reserve Bank but not by an amount exceeding 
■$25,000,000 in any one year. Even if the National Bank should 
take full advantage of this opportunity, which so far they have 
not, it would be impossible to retire in the given period much 
more than a half of the $743,290,374 National Bank Notes out- 
standing at the close of the fiscal year 1918. At the same date 
the total stock of Federal reserve bank notes amounted to 
$150,772,400. 

FEDERAL RESERVE NOTES 

The latest thing in money in the United States is the Federal 
Reserve Note from which great things are hoped on account of 
its ability to expand and contract in response to the needs of 
trade. There is no doubt as to the former of these powers, for 
its issue has increased with remarkable rapidity from $1,215,000 
on November 20, 1914, to over two billion and a half on June 
30, 1920. At the close of the fiscal year 1921 they decreased by 
$405,447,260. 

These notes are obligations of the United States; they are 
issued at the discretion of the Federal Reserve Board to any 
Federal Reserve Bank upon the deposit of rediscounted com- 
mercial paper. They are secured by an equal amount of such 
paper, by a forty per cent gold reserve, not less than five per 
cent of which must be deposited with the Secretary of the 
Treasury for the redemption of the notes, they also constitute a 



236 PRACTICAL ECONOMICS 

first lien on the assets of the issuing bank. They are redeemable 
in gold or lawful money at any Federal Reserve Bank or in gold 
at the Treasury. They are neither legal tender nor lawful 
money, but are receivable for all taxes, customs and other 
public dues. 

GOLD THE BASIS OF UNITED STATES MONETARY 

SYSTEM 

One central fact emerges from a study of the monetary sus- 
tem of the United States, namely, that all forms of money 
issued are based on a certain weight of gold. This is nowhere 
more clearly brought out than in the words of the Gold Standard 
Act of March 14, 1900. 

Be it enacted, etc., that the dollar consisting of twenty-five and 
eight-tenths grains of gold nine-tenths fine, as established by section 
thirty-five hundred and eleven of the Revised Statutes of the United 
States, shall be the standard unit of value, and all forms of money 
issued or coined by the United States shall be maintained at a parity 
of value with this standard and it shall be the duty of the Secretary 
of the Treasury to maintain such parity. 

This parity of value between all kinds of money and the 
standard of value is secured first through the interchangeability 
of gold coin and gold bullion by means of free coinage on the 
one hand, and the melting pot on the other. Should the value 
of the coin exceed the value of the bullion on the coin, gold by 
virtue of free coinage will flow into the mints, decreasing the 
supply of bullion till its value equals that of the coin. Should 
the value of the coin be less than that of its bullion content, coin 
will flow into the bullion market through the melting pot and 
the value of the bullion will decrease until they are again equal. 
Thus by the interchangeability of coin and bullion, gold coins 
are kept at an equality of value with gold. Further, by making 
all other forms of money redeemable in gold coin they are kept 
at a parity of value with gold coin and therefore with gold. 

In the United States the unit medium of exchange which is 
universally acceptable in final payment of all debts both public 
and private is the dollar of 25.8 grains of gold nine-tenths 
fine. This is the unit to which all things exchanged for money 



MONEY 237 

are compared and in terms of which their values are expressed. 
This weight of gold minted into coins constitutes the real money 
of the nation; all other forms of money being based on it are 
subsidiary or supplementary to it. 

BIMETALLISM 

A nation may select two metals to serve as standard money, 
in fact up to a hundred years ago, in most countries both silver 
and gold were standard money. Such countries are said to have 
a double or joint standard or to be on a bimetallic basis. 

Bimetallism means the free coinage of both silver and gold, 
with both kinds of coin endowed with full legal tender power. 

The monetary unit consists either of a certain weight of 
silver or a smaller weight of gold so selected that their values 
coincide. The first coinage law of the United States passed in 
1792 defined the "Dollar or Units" each to be of the value of a 
Spanish milled dollar and to contain either 371 4/16 grains of 
pure silver or 24.75 grains of pure gold. There were thus two 
kinds of dollars in the States in 1792, gold and silver; value was 
measured by both or by either a certain weight of gold or a 
certain weight of silver, but as each of these was equal or sup- 
posed to be equal in value to the other, there was but one 
standard value, the joint value of the two. 

The government in deciding on the two monetary units is 
said to establish a "ratio" between gold and silver, sometimes 
referred to as the "mint ratio." By ratio is meant the relation 
between the unit weights of the two metals. In 1792 Congress 
established a ratio between silver and gold of fifteen to one. The 
standard silver dollar of 371 4/16 grains was fifteen times the 
weight of the gold dollar of 24.75 grains; the United States 
mints coined both metals into dollars at the rate of fifteen ounces 
of silver to one of gold. 

In determining the mint ratio the government ascertains the 
relative values of the two metals in the bullion market. If 
in the bullion market fifteen ounces of silver are equal in value to 
one ounce of gold, the weights of the two standard units are fixed, 
so that the silver unit is to the gold unit as fifteen to one. If the 
mint ratio is ascertained correctly the two standard coins will be 



238 PRACTICAL ECONOMICS 

equal in value. Bimetallism means, then, two unit weights of 
metal so chosen as to be equal in value. The real standard of 
value is the joint value to which the values of the respective 
weights of metals coincide. 

THEORY AND PRACTICE 

The theory of bimetallism is that the joint value will fluctuate 
less than the value of either metal alone. This is based on the 
assumption that when two metals are freely coined, if the value 
of one should increase in the bullion market, coins of that metal 
will be melted down and sold for bullion the price of which will 
then tend to sink; while on the other hand should the bullion 
price of one metal fall, the increased demand for it as money will 
tend to raise its value. Any fluctuations in the bullion value of 
either of the two metals due to changes in demand or supply 
would be counteracted by changes in the monetary demand for 
that metal, so that the market ratio would tend to correspond 
permanently to the mint ratio. 

Though this might be possible in the case of universal bimetal- 
lism, or if the great nations of the world were to go on a bimetal- 
lic basis, past experience has demonstrated that the monetary 
demand of any one nation has been insufficient to counteract 
changes in value of one or other of the metals due to changes in 
supply. In practice the weakness of bimetallism has sprung 
from the fact that as soon as the market ratio varies from the 
fixed mint ratio, the equality of value between the two coins 
ceases, one is worth more as bullion and disappears from 
circulation. 

Accordingly the monetary history of most countries shows 
that the bimetallic standard means an alternating standard, the 
metal which is undervalued going out of circulation, while the 
overvalued metal stays and becomes for the time the standard 
of value. 

GRESHAM'S LAW AND BIMETALLISM 

This tendency is often spoken of as Gresham's Law, the usual 
statement of which is that poor or bad money drives out good. 
When coins are worth more as bullion than as money, they will 



MONEY 239 

be either melted for use in the arts or exported. When two 
metals are in circulation together, that which is worth more as 
bullion than as money is said to be undervalued while that which 
is worth more as money than as bullion is spoken of as over- 
valued. People will seek to pay their debts with the poorer 
money and hoard, export or sell as bullion the other. Not only 
so but the metal undervalued as money will not be brought by 
miners to the mint, but will seek the bullion market when its 
value is greater. This is what happened in the United States 
after 1792, either the ratio of fifteen to one undervalued gold or 
the market ratio of the two metals changed after 1792, for one 
ounce of gold in the bullion market was worth 151/^ ounces of 
silver; the mint ratio in effect made one ounce of gold equivalent 
to but fifteen ounces of silver, with the result that no gold was 
brought to the mints while that in circulation disappeared. After 
1834 Congress changed the ratio to sixteen to one which under- 
valued silver as much as the previous ratio had gold, silver now 
disappeared and gold become the standard money in use. The 
history of other countries bears similar testimony to the alternat- 
ing nature of the bimetallic standard. 

TEST QUESTIONS 

1. What are the two primary functions of money? 

2. Mention the chief qualities of a good money. 

3. What is the relationship of a government to money? 

4. What is meant by the phrase "adopting a standard"? 

5. What is "standard" money? 

6. What is "supplementary" money? 

7. Name the ten kinds of money in the monetary system of the United 
States. 

8. How are the various kinds of supplementary money in the United 
States kept at a parity with gold? 

9. What is bimetallism? 

REFERENCES 

Bagehot, W., Lombard Street. 

Carver, T. N., Principles of Political Economy (Chap. XXIV). 
CoNANT, C. A., The Principles of Money and Banking. 
Clay, H., Economics for the General Reader (Chap. IX). 
Jevons, W. S., Money (Chaps I-XVI, XXV-XXVI). 
Johnson, J. F., Money and Currency. 



240 PRACTICAL ECONOMICS 

Jones, E. D., Economic Crises. 

Kemmerer, E. W., Money and Credit Instruments in Their Relation to 

General Prices. 
KiNLEY, D., Money. 

Laughlin, J. L., The Principles of Money. 

Marshall and Lyon, Our Economic Organization (Chaps. XVIII-XX). 
Mill, J. S., Principles of Political Economy (Book III, Chaps. VII-X). 
Palgrave's Dictionary of Political Economy (Vol. 2, p. 787). 
EiCARDO, D., Principles of Political Economy and Taxation (Chaps. XXVII 

and XXVIII). 
RiDGEWAY, W., The Origin of Metallic Currency. 
Say, J. B., Pohtical Economy (Chap. XXI). 

Seligman, E. R. a., Principles of Economics (Chaps. XXVIII and XXIX). 
Smith, A., Wealth of Nations (Book I, Chap. IV). 
Summers,* W. G., History of American Currency. 
White, H., Money and Banking. 



CHAPTER XXI 
DEPOSIT CURRENCY AND BANKING 

Thus far we have discussed standard money and those other 
media of exchange of general acceptability, based upon and sup- 
plementing it, commonly termed money. But there remains 
another medium, based upon money and supplementing it in its 
work of effecting exchanges to a greater extent than all the 
previously mentioned forms put together, namely — deposit 
credits circidating in the form of checks. 

WHY NOT CLASSED WITH MONEY 

Though closely allied to the supplementary forms of money 
treated in the last chapter and often preferred to them as a 
means of payments as they are preferred to gold, it is not usually 
classed as a form of money, for the reason that it lacks the 
general acceptability enjoyed by these other media. That all 
these differ from the check in that they circulate freely from 
hand to hand without question, while the check, though just as 
acceptable to certain people and even preferable, is not so to 
everyone, but is limited by personal or local conditions, so that 
its range of acceptability is narrowed, will be evident to all. 
There are other differences, of course, but this, based on the 
fundamental requirements of a good money, accounts for the 
fact that economists do not classify it as money but deposit 
currency: Currency being a wider term including all forms of 
circulating media of exchange. 

WHAT DEPOSIT CURRENCY REALLY IS 

Though differing from the other forms of currency in respect 
to general acceptability, it is in many respects similar to them. 
It is issued in terms of standard money and serves to supplement 
it as a medium of exchange; it is based on gold ultimately so its 

241 



242 PRACTICAL ECONOMICS 

value, like that of the United States note, depends on its con- 
vertibility into standard money. It is true that it is a step 
further removed from its base than the United States note 
which is directly convertible, whereas a deposit is payable in 
legal tender money which in turn is exchangeable for the 
standard. 

Like the United States note, it is not money but a promise to 
pay money. Both the United States note and the deposits are 
forms of credit, the one of the government, the other of the bank. 
There is still a greater similarity between the bank note and 
the deposit, both are in effect the bank's promises to pay money 
on demand, the chief difference being that the bank note passes 
directly from hand to hand while the deposit circulates by means 
of the check. 

Deposit currency is in reality a form of circulating bank credit. 
Credit may be defined either as a promise to pay money or a 
right to the use of money. The record of this promise or right is 
termed a "credit instrument" such as a United States note or a 
promissory note which the business man signs when he borrows 
money from the bank. Both of these are written evidences of 
promises to pay money, both also constitute rights to money, 
claims on the promisers to money. These credit instruments 
may, as we have seen, be used to effect exchanges in place of 
actual money being as acceptable as the money they constitute 
a claim to. They vary greatly in the degree to which they 
possess the quality of acceptability. The personal note of an 
individual possesses a very narrow range of acceptability and is 
unfitted to become a medium of exchange, but that of a well 
known bank has a wider range and that of the United States 
government is so generally acceptable that its promises to pay 
are as good as money in any part of the country. A modern 
bank deposit is in effect the bank's promise to pay money on 
demand — a promise evidenced on the pass book of the bank's 
creditor. This deposit credit constitutes a claim on the bank 
for money which the depositor is able to transfer to others by 
means of a written order. The check is the instrument by 
which the depositor's claim on the bank is transferred to others; 
it is a means for the transfer of bank credit from one to another. 



DEPOSIT CURRENCY AND BANKING 243 

It is so generally acceptable as to be used as a medium of 
exchange. Deposit currency is thus a form of bank credit cir- 
culating by means of an order called a check. 

THE TWO WAYS IN WHICH DEPOSIT CREDIT ARISES 

Deposit currency issues from the loans of the banks and its 
use as a medium of exchange is made possible by the mechanism 
of the banking system. The banking system of the country may 
be said to serve two purposes, — first, it provides a means for the 
collection of savings and their investment; second, it furnishes 
an elastic currency for the use of the business community. The 
first of these functions is performed largely by the savings banks 
and private banks, the second by the commercial banks which 
include national and state banks and trust companies. It is 
the latter group that gives rise to deposit currency, to understand 
the nature of which we need to see how demand deposits come 
into being in these institutions. 

A deposit credit may arise either through an actual deposit of 
cash or as the result of a loan by the bank to the depositor. 
Originally the deposit involved, as the word suggests, an actual 
deposit of money ; and the practice is still common, the personal 
accounts of salaried and professional men being of this class. 
But the great bulk of modern demand deposits come into 
existence as the outcome of loans made by the banks to business 
men. In the typical loan transaction the borrower signs a note 
promising to pay we will say $500 in sixty days from date, in 
exchange for the note the banker gives the borrower a deposit 
credit equal to the face value of the note minus interest at the 
current rate for the period of the loan. Whether the deposit 
credit springs from an actual deposit of cash or is the outcome 
of a loan, it exists in both cases as a credit on the books of the 
bank, a claim against the bank to pay money on demand. 

HOW THE BANKS ARE ABLE TO CREATE CREDIT 

In opening up deposit accounts against which no actual deposit 
of cash has been made, the banks are sometimes said to create 
credit. We shall see how the banks are able, with a few strokes 



244 PRACTICAL ECONOMICS 

of the pen, to create a currency that is preferred by the business 
community to money itself as a medium of exchange. 

Now the commercial bank is a business institution, the chief 
function of which is to loan money and credit at a profit, but 
the great bulk of its loans today are made in the form of credit. 
The loaning of credit by banks has been practiced from time 
immemorial but the mechanism of the modern bankmg system 
has tremendously extended the banks' capacity to create this 
profitable and serviceable substitute for money. The ancient 
banker who received money on deposit was usually in business 
for himself and as all the money deposited with him would not 
be demanded at any one time, soon developed the practice of 
using part of the funds in his own affairs, and loaning part out 
to others at interest and it is likely that at first he loaned out 
actual cash. It is evident that such a banker or money lender, 
if tied down to make loans in cash, would be limited in the 
amount of his loans by his total cash assets minus a reserve 
sufficient to pay the current demands of his depositors. Now it 
is easy to surmise how the more profitable practice of creating 
and lending credit arose. The ancient merchant who had 
deposited his moneys with the banker for safe keeping, would 
for convenience sake when making a payment give his creditor 
his deposit receipt or an order on the banker for the money; 
such an order is the prototype of the modern check. The 
creditor instead of drawing out the cash would often prefer to 
leave it in the custody of the bank receiving a deposit receipt in 
return and make his payments in the same way. As this cus- 
tom developed, and it did so at a very early date, borrowers of 
money would also come to prefer instead of actual cash, a 
deposit credit against which at their leisure they would draw 
orders that could be used in the payment of their debts. 
Instead of handing his borrower cash the banker now gave him 
a claim to cash payable on demand. He lent now not cash but 
his credit and as but a small part of these claims to money 
would normally be demanded at any one time, he was able to 
create a larger volume of claims than he possessed money. His 
loaning power was much increased. With the establishment of 
the custom of payment by check in the business world added 
to the clearing house mechanism of the modern banking system 



DEPOSIT CURRENCY AND BANKING 245 

for the offsetting of checks, the cash demands on modern banks 
are remarkably small, being in normal times less than 5 
per cent of their deposits. Thus a bank's ability to create 
credit which can be loaned out at interest to business men, and 
which furnishes them with purchasing power, is tremendously 
increased. 

To get a bird's-eye view of the modus operandi of this 
ingenious system let us return to our borrower who has exchanged 
his note for a deposit credit at the bank. He will be likely at 
first to draw heavily against his balance but as in the ordinary 
course of his affairs payments are made to him and deposited, 
he will increase his account in anticipation of the maturity of the 
note and when it is due he will most likely pay by check, thus 
closing the transaction. The average bank will have hundreds 
of borrowers and depositors carrying on these transactions in an 
endless series: while some are borrowing and drawing heavily 
on their accounts, others are depositing and preparing for the 
payment of their notes. The claims that are continuously being 
presented against the bank by its clients are thus largely can- 
celled by the continuously maturing claims of the bank on them. 

Not only so, but the check which the depositor draws, will in 
most instances, never be paid in cash. The creditor to whom 
our depositor makes out his check will ordinarily deposit it in 
his bank. In the possession of this second bank it constitutes a 
claim on the first. In like manner another check drawn by a 
depositor of the second bank and deposited by his creditor into 
the first would constitute a claim on the second bank. At the 
"clearing house" these two banks would offset these two claims 
against each other, thus obviating the payment of any cash. 
The banking system is thus a mechanism within which these 
claims on the different banks are transformed into deposits in 
others and settled for the most part by cancellation. The net 
result is that the banks are able to create and maintain a large 
volume of deposit credit with but a relatively small use of cash. 

HOW BANK CREDIT SERVES AS A MEDIUM OF 
EXCHANGE 

We have seen how the banks are able to create deposit credit 
through the agency of the check and the mechanism of the bank- 



246 PRACTICAL ECONOMICS 

ing system, we will now, by a closer examination of that same 
mechanism, notice how deposit credit is substituted for money 
as a medium of exchange. 

The deposit credit is a claim on the bank for the payment of 
cash on demand ; a claim that is able to be transferred to another 
by means of an order termed a check. If, however, that other 
cashes his claim, taking the check to the banker for payment, it 
is evident that the deposit credit has merely postponed the pay- 
ment of money and not dispensed with it. If Smith, a retail 
grocer, gives his wholesaler a check in payment for a consign- 
ment of sugar, and the wholesaler cashes the check at Smith's 
bank, no economy of money has been achieved. But as we have 
stated, the check in the majority of cases will be deposited in 
the payee's bank and settled by offset without the use of money; 
in which event the exchange of commodities will be effected by 
the check acting as the medium of exchange in place of money. 

In order to see how deposit credit circulating through check 
is able to achieve this remarkable economy of money, we will 
take the simplest case first of a buyer and seller having accounts 
in the same bank. Smith buys a barrel of apples from Brown 
paying with a check which Brown deposits in the bank. This 
transaction involves a transfer of credit from Smith's account to 
Brown's through the instrumentality of the check. The bank 
debiting Smith's account and crediting Brown's with the amount 
of the check. The sale has been made and Brown paid without 
the passage of a penny, — a truly phantom transaction made 
with ghost-money, yet commercially sound and legally satisfac- 
tory. Were there but one bank in a community with which all 
citizens had accounts, no money would be required at all; pur- 
chases and sales could be made by checks and the different 
accounts debited or credited accordingly. 

Were there two banks in the community. Smith belonging to 
one and Brown to the other. Smith's check when deposited would 
constitute a claim in the possession of Brown's bank on Smith's. 
Brown's bank would take Smith's check with other claims on 
the latter's bank and offset them against claims on it in the 
possession of Smith's bank, only the difference being paid in cash 
and not even that if a running balance were kept between the 



DEPOSIT CURRENCY AND BANKING 247 

two banks. Smith's check on being returned to his bank would 
be cancelled and his account debited, Brown's account would be 
credited and the exchange would be effected as before without 
the payment of money. 

This process of offsetting claims is extended indefinitely in 
our modern banking system through the clearing house. In a 
community without a clearing house each bank would be obliged 
to send a messenger to those banks against which it had checks 
and collect or offset them. In a clearing house these messengers 
all meet at an appointed time, each presenting all the checks 
it holds on other banks and in turn receiving all those the other 
banks hold on it. A balance is then struck between the total 
claims of each bank on all the others, and the total claims of 
all the others on each individual. The balance is then received 
or paid by each bank to the Clearing House Association, in cash 
or by check, probably by a check on the Federal Reserve Bank 
of the district. In London the clearing house meets twice daily, 
the annual clearings run to over twenty billion pounds ; the bal- 
ances which are less than 5 per cent of the total clearings, are 
paid by checks on the Bank of England, so that literally billions 
of payments are made without the use of a single sovereign. The 
total clearings in the New York Clearing House for the week 
ending January 3, 1920, amounted to $4,387,455,948 and the 
total clearings of all the clearing houses of the United States for 
the same week exceeded nine billion dollars. The total clearings 
of the New York Clearing House for 1920 amounted to more 
than two hundred and fifty-two billion dollars, the balances 
being 9.99 per cent of the total. During the last sixty-five years 
in the New York Clearing House, the balances have averaged 
but 5.19 per cent of the clearings. 

By means of the interconnections between banks the deposit 
credit is used to make payments to distant places. Banks have 
their correspondents in other cities with whom they maintain 
deposits and through whom they collect payments of checks 
drawn on those cities and on whom they draw drafts for their 
clients who wish to make out-of-town payments. The collection 
of out-of-town checks and the making of out-of-town payments 
has been much facilitated by the passage of the Federal Reserve 



248 PRACTICAL ECONOMICS 

Act under which the Federal Reserve Banks are authorized to 
collect checks and drafts on member banks and on each other 
at par. 

This remarkable mechanism of the banking system for the 
offsetting of claims one against another, enables deposit credit 
circulating through checks and drafts to effect millions of pay- 
ments with but a minimum use of cash, thus furnishing the 
community with a cheap and convenient substitute for money as 
a medium of exchange. 

HOW DEPOSIT CURRENCY IS SECURED; THE CASH 

RESERVE 

It miglit be well to note that the word "substitute" is here 
used in a limited sense ; not meaning that deposit currency is able 
to displace money but to represent it, acting for it as a hand-to- 
hand medium of exchange. All credit instruments are claims to 
money; a United States note is a claim on the government for 
gold, a bank note or a check is in effect a claim on a bank for 
money; these claims to money are acceptable as media of ex- 
change only so long as there is no doubt but that the money 
they lay claim to will be forthcoming as required. Under ordi- 
nary conditions such is the confidence of the public in the 
government and the banks that the credit instrument of either 
readily pass from hand to hand in lieu of the money they are 
entitled to; in consequence their ultimate dependence on stand- 
ard money is apt to be overlooked and some over-sanguine 
souls are even lured into the belief that credit is a thing apart 
from money, fully capable of existing without it and able to 
completely supplant it. One might as well believe that a house 
can exist without a foundation. For our entire system of credit 
currency is based on gold. Witness today the sunken condition 
of European currencies due to the weakening of the gold 
foundation on which they rest. It should never be lost sight of 
that all forms of credit currency are promises to pay money and 
only circulate in place of money at par, because of the fact that 
the public has confidence that the money promised will be paid 
if demanded. A credit instrument occupies a rather paradoxical 
position. If the holder is satisfied that he can obtain the money, 



DEPOSIT CURRENCY AND BANKING 249 

he does not want it, but let him once doubt and he at once wants 
the money. This is particularly true of deposit credit. Let a 
rumor get abroad that a certain bank is shaky and its depositors 
will descend on it in a swarm demanding cash. Credit is based 
on confidence but that confidence is based in turn on ability to 
pay money and this ability must be assured. In the case of 
credit currency payable on demand, this assurance can only be 
secured by a cash reserve. We have seen how the supplementary 
forms of money issued by the government and the banks are 
secured by cash reserves, which assure their ready convertibility 
into standard money on demand. We will now notice how the 
convertibility of deposit currency into money is secured by bank 
reserves. 

In a general way, of course, the deposit liabilities of a bank 
are secured by its assets, but as these deposits are subject to 
payment in legal tender money on demand, it is essential that 
part of its assets should consist of cash. As a bank makes its 
profit by loaning money and credit it naturally does not desire 
to keep any more cash in its vaults than is conservatively neces- 
sary to insure the prompt payments of its depositors' demands, 
which as we have seen are small in normal times in comparison 
to its deposits. To keep any more idle cash than is conserva- 
tively necessary is wasteful, entailing loss to the banker and 
to the business man needing capital. On the other hand there 
lies the danger, owing to the fact that the more loans the 
banker makes the larger his profits, that he will be tempted to 
extend his loans beyond the point of safety; be unable to meet 
an unusual demand for cash and become involved in ruin. No 
bank, no matter how strong, could stand a run on it, could pay 
all its deposits in cash if demanded at any one time. This does 
not mean that banks are insolvent, but that the banks' assets 
are not all cash or convertible into cash at a moment's notice. 
A large part of its assets will consist of the notes of business 
men, payable within thirty to ninety days. These are sound 
assets convertible into cash, but not immediately. The question 
resolves itself into the proportion of cash assets a bank should 
hold against demand liabilities. 

In Europe generally the proportion of cash reserves to deposit 



250 PRACTICAL ECONOMICS 

liabilities is left to the judgment of the bankers. The advan- 
tages of this system over that of a legal minimum are that it is 
in the first place more economical, in that it allows the banks 
to adjust their reserves to the temper of the times, reducing the 
amount of idle cash in periods of confidence, increasing them 
only as occasion warrants; second, that it is safer in that it 
throws the full responsibility for maintaining an adequate 
reserve on the banker who thus charged is constantly on the alert 
to strengthen his reserves in anticipation of an approaching 
storm, instead of relying on a rigid legal minimum, which though 
it may be in excess of requirements in ordinary times is insuffi- 
cient in times of panic. In England, owing to the fact that the 
reserves are concentrated at one point, all the banks keeping the 
greater part of their cash reserves in the form of deposits with 
the Bank of England, the proportion of reserves to depositors 
is smaller than in any other country, usually less than 5 per 
cent. 

In the United States it is customary to determine by law the 
minimum proportion of cash reserves to demand deposits. The 
purpose is to protect the public against an unsafe extension of 
loans on an insufficient reserve by compelling the banks to cease 
loaning when their cash reserve falls below the prescribed legal 
requirements. This acts as a check on careless or rash banking 
practice. In a young country where the banking system is not 
highly organized, where banking practice and banking ethics 
are still in the formative stage and that sound conservative 
judgment, on which finally the safety of any bank system de- 
pends, has not yet emerged from the fires of experience, legal 
restriction is without question desirable. And such no doubt 
has been the case within the United States in the past. Whether 
such restriction is still necessary is doubtful though the reserve 
requirement of the Federal Reserve Act suggests it is still 
expedient. 

For the purpose of reserves we may divide the commercial 
banks of the United States into two groups, one consisting of 
the national banks and member banks of the Federal Reserve 
system, the other containing all banks outside of the national 
system, state banks including trust companies, the aggregate 



DEPOSIT CURRENCY AND BANKING 251 

demand deposits of which in 1918 were about seven billion dol- 
lars. The reserves of this second group are determined by the 
laws of the different states, among which, to say the least, there 
is considerable variation, some being stringent and others 
remarkably lax. The legal minimum required runs from zero 
to 25 per cent, although 15 per cent is the most common require- 
ment for demand deposits. 

The Federal Reserve Act of 1913 while it reduced the existing 
reserve requirements of the individual banks of the national 
system, rendered them far more mobile and effective by creating 
a reserve organization with a high degree of centralization of 
control. Under the old national banking system the reserves 
of the banks throughout the country gravitated to the three 
central reserve cities, particularly New York. This local con- 
centration of reserves lacked the one thing needful of concen- 
tration, namely centralization of control. The reserves were 
scattered among the big banks in the central reserve cities, each 
of which concerned chiefly with its own affairs, loaned these 
funds out on call to brokers, no one was responsible for their 
availability in anticipation of a demand for cash from the 
country at large; as a result when a panic arose the New York 
banks, themselves caught short of cash, called their loans and 
suspended payments. The banks throughout the country, unable 
to get their reserves deposited with the New York banks, like- 
wise contracted their loans and disaster followed. In short, 
under the old system the reserves were scattered in separate 
banks, with the result that in times of danger no concerted plan 
of action was possible. Under the new Federal Reserve system 
the reserves are marshalled in twelve Central Reserve Banks, 
each of which is the center of control for its district ; provision for 
concerted action between these district centers is provided 
through the agency of the Federal Reserve Board, so that while 
there is not the complete centralization afforded by the English 
system, there is a high degree of centralized control for the 
reserves of each district. 

Under the Federal Reserve system the country banks are 
required to maintain a reserve of 7 per cent, banks in reserve 
cities 10 per cent and those in the central reserve cities, 13 per 



252 PRACTICAL ECONOMICS 

cent. Part of these reserves are to be kept in the bank's vaults 
and part on deposit with the Federal Reserve Bank of its dis- 
trict. Each of these reserve banks is the reservoir for its district 
and as it is itself a bank of deposit, it is required to maintain a 
reserve of gold or lawful money equal to 35 per cent of its 
deposits, as well as the 40 per cent gold reserve against its notes 
in circulation not secured by gold or lawful money deposited 
with the Federal Reserve agent. 

REINFORCEMENT OF CASH RESERVES BY LIQUID 

ASSETS 

Not only does sound banking demand an adequate cash re- 
serve, but it is just as essential for a bank to keep its assets in a 
liquid state, by which is meant that they should be in such a 
form as to be readily convertible into cash. The assets of a 
national bank, aside from cash, are "loans and discounts," United 
States bonds, and other securities and bank property. Chief of 
these is the item, loans and discounts, which consist of promissory 
notes, trade acceptances and other evidences of claims against 
its borrowers that the banker has in his portfolio. It is by regu- 
lating the character of these loans and discounts that the banker 
is able to keep his assets liquid. From this point of view we 
may divide these loans into two classes, call and time loans. 

In the big cities, particularly New York, the banks lend part 
of their spare funds to brokers. These loans are secured by col- 
lateral, stocks or bonds, deposited with the banker as security 
and repayable at any time at the call of the banker. This 
enables the banker to loan out his funds at interest and yet retain 
control of them. These loans constitute the most liquid of assets, 
being convertible into cash at a few hours' notice. 

The great bulk of the loans made by commercial banks run 
from thirty to ninety days. The most common form is the 
promissory note referred to above. A new form in this country, 
though one which has been for years a favorite in Europe, is the 
"trade acceptance," which bids fair to increase in popularity here. 
A trade acceptance is a draft or bill of exchange drawn by the 
seller on the purchaser of goods, bearing on its face the pur- 
chaser's signature as evidence of acceptance, with the date and 



DEPOSIT CURRENCY AND BANKING 253 

place of payment. The seller or buyer takes this acceptance to 
the banker, who in exchange for it gives him a deposit credit 
equal to its face value, minus the interest charge for the period of 
the loan. Loans of this character are a favorite with bankers, 
secured as they are by two names, based on merchandise in 
transit and tying up the banker's funds for but a short time. 
Long-term loans are not favored by commercial banks, tying up, 
as they do, their funds for long periods. Up to the passage of 
the Federal Reserve Act no national bank was allowed to loan 
money on the security of farm lands. The new act permits a 
national bank not in a central reserve city to make such loans, 
not to run longer than five years and not to exceed in volume 25 
per cent of its capital and surplus or one-third of its time 
deposits. 

How a bank is able to reinforce its cash reserve by keeping 
the bulk of its loan assets in such a form as to be convertible 
into cash at short notice will now be clear. Over against its 
demand liabilities it has its loans in such a form and arranged in 
such a way as to be coming due daily. Moreover, the banker is 
able to contract or expand them as his judgment dictates. In 
periods of confidence when business is good, when a smaller cash 
reserve is necessary and more loans demanded, he can extend 
his accomodations. When the storm signals of an approaching 
panic are flying, he is able to shorten sail by gradually contract- 
ing his loans, at the same time increasing his cash reserve. Here 
again the Federal Reserve Act has come to the rescue and given 
greater elasticity and mobility to bank credit than ever it had 
before, by "rediscounting" and the establishment of an open 
discount market. 

By "rediscounting" is meant that the Federal Reserve Bank 
will discount the note or trade acceptance which the banker 
has discounted for the business man, loaning the banker money 
on it, as he has previously loaned money to the business man. 
Heretofore such a note must lie idle in the banker's portfolio 
until it came due, now he is able to borrow money on it. This 
law makes good commercial paper the banker's most liquid asset. 
In times of stress he can always obtain cash by taking his prime 
commercial paper to the Federal Reserve Bank and getting it 



254 PRACTICAL ECONOMICS 

rediscounted. Also under the new law the Federal Reserve 
banks and the member banks are allowed under certain lim- 
itations to buy and sell bank acceptances and bills of exchange 
arising out of foreign and domestic trade. Any bank with funds 
to spare may buy such commercial paper and when in need 
of cash can sell it in the open market. Add to this the fact that 
the Federal Reserve Banks may, or may be required by the Fed- 
eral Reserve Board to, rediscount each other's paper, making 
it possible for any one reserve bank in times of stress to obtain 
cash aid from the other reserve districts, and we have a reserve 
system which should afford ample protection and fully guarantee 
the convertibility of deposit currency into cash at all times. 

GROWTH AND PRESENT STRENGTH OF BANKING IN 
THE UNITED STATES 

Some idea of the rapidity of growth in banking in the United 
States during the last fifty years is gained from the following 
chart. Fig. 11., which graphs in billions of dollars the individual 
deposits in National, State, savings, private banks, loan and 
trust companies in decades from 1870 to 1920. The increasing 
steepness of the curve well displays the remarkable recent 
rapidity of growth of banking practice in this country. 

In 1890 the banking power of the United States was estimated 
by Mulhall to be $5,150,000,000, in 1920, as expressed by the 
aggregate of the capital, surplus, deposits, and circulating notes 
of its National, State and Federal Reserve Banks it had grown 
to $50,981,900,000. The total individual deposits in all banks 
in the United States in 1920 amounted to $37,683,600,000. 

The resources of national banks in the seven-year period from 
June, 1920, increased $11,159,817,000 which is more than the 
total increase which took place in the entire fifty years from the 
inauguration of the national banking system in 1863 to the 
year 1913. 

All previous records were exceeded in 1920 in the number of 
depositors in national banks which according to the report of 
the comptroller of the currency numbered 20,520,177. There 
is now approximately one depositor in the national banks for 
every five of the population. 



DEPOSIT CURRENCY AND BANKING 



255 



In immunity from failure the showing for the year 1920 was 
the best in forty years, with the sole exception of the fiscal year 
1919. The total capital of the five small banks which failed 
during the year was $225,000 or seventeen one thousandths of 1 
per cent of the total capital of all national banks. This per- 



1870 
38 



36 



1880 



1890 



1900 



1910 



1920 



30 



25 



O 
•H 20 



10 









37,633.6 milliani^ 










/ 










/ 










/ 






15,2S 


3.4 millions -i^ 


/ 














6,23 


9.0 millions-^ 






4,004.1 millions^ 
1.951.6 million a..*^' 









1870 



1880 



1890 1900 

Fig. 13 



1910 



1920 



centage is about sixteen times better than the average for the 
entire period of fifty-seven years from the inauguration of the 
system to the present. 

An annual charge of two and one-half ten thousandths of 1 
per cent of deposits would have been more than sufficient to 
have covered all losses, accruing to the depositors in national 



256 PRACTICAL ECONOMICS 

banks for the six years preceding 1920. All deposits in na- 
tional banks could thus be fully insured by payment of a 
premium of $25 per million and such a plan has been sug- 
gested by the comptroller of the currency. 

The growth and present strength of the national banking 
system is well brought out in the following table: 

THE MONEY AND CURRENCY OF THE UNITED STATES 

The relative quantities of standard money, supplementary 
money and deposit currency in the United States at the close of 
the fiscal year June, 1921, are pictured by the following diagram: 




$4,801 mlns 
$3,780 mlns 

Total $24,587 billions 



Fig. 14 



The basis of our whole system of money and currency is the three 
billion odd dollars of gold, the standard money of the realm. 
Next comes the four and a half billion of supplementary money 
possessing the same general acceptability within the nation as a 
hand-to-hand medium of exchange as the gold into which it is 
directly convertible and on which its value depends. On the top 
of the whole is the ^sixteen billion of bank credit circulating 
through checks, depending for its value on its convertibility into 
legal tender money, supplementing such money as that in turn- 
ing supplements gold. 

Not only in the workshop of the world has evolution replaced 
the tool by the machine, taking it out of man's hands and setting 
it in a mechanism wherein its power to produce is magnified. 

'No satisfactory figures available for 1921. Based on estimate for 1920. 



DEPOSIT CURRENCY AND BANKING 
(In thousands of dollars) 



257 



Date 



No. of 
banks 



Total 
deposits 



Loans and 
discounts 



Reserve 
held 



Excess 



Sept. 


5, 


1900 


3,871 


3,699,804 


2,686,760 


983,333 


299,206 


Aug. 


25, 


1905 


5,757 


5,508,643 


3,998,509 


1,294,298 


322,170 


Sept. 


1, 


1910 


7,173 


7,140,836 


5,467,161 


1,573,522 


313,415 


Sept. 


2, 


1915 


7,613 


9,229,516 


6,756,680 


1,969,398 


868,756 


Sept. 


8, 


1920 


8,093 


16,751,956 


13,706,066 


1,232,039 


38,092 



Capital 



Surplus and un- Circula- Total No. of 

divided profits tion resources banks 



Date 



630,299 


389,469 


283,949 


5,048,138 


3,871 


Sept. 


5, 


1900 


799,870 


620,294 


468,980 


7,472,351 


5,757 


Aug. 


25, 


1905 


1,002,735 


874,038 


674,822 


9,826,181 


7,173 


Sept. 


1, 


1910 


1,068,864 


1,022,596 


718,496 


12,267,090 


7,613 


Sept. 


2, 


1915 


1,248,271 


1,456,067 


693,270 


21,885,480 


8,093 


Sept. 


8, 


1920 



In the market place the same silent forces have been at work; 
money the tool of exchange no longer performs its task by hand, 
but as part of a marvelously ingenious mechanism, its power to 
affect those exchanges of capital and finished goods on which the 
well being of our society depends, has been tremendously aug- 
mented. 

TEST QUESTIONS 

1. What is the distinction between deposit currency and the other kinds 
of currency discussed in the preceding chapter? 

2. How does deposit currency originate? 

3. How does deposit currency serve as a medium of exchange? 

4. Show how checks are offset against one another in the clearing house. 

5. How is deposit currency secured? 

6. Explain how cash reserves are reinforced by liquid assets. 

7. What is "rediscounting"? 

REFERENCES 

Carver, T. N., Principles of Pohtical Economy (Chap. XXV). • 

CoNANT, C. S., Wall Street and the Country. 

Clay, H., Economics for the General Reader (Chap. X). 

FiSKE, A. K., The Modern Bank. 

Hepburn, A. B., History of Currency in the United States. 



258 PRACTICAL ECONOMICS 

HoLDSWORTHj J. T., Money and Banking. 
Johnson, J. F., Money and Currency. 

Kemmerer, E. W., Modern Currency Reforms; The A. B. C. of the Fed- 
eral Reserve System. 
Keynes, J. M., Indian Currency and Finance. 
KiRKBRiDGE and Sterrett, The Modern Trust Company. 
Laughlin, J. H., Banking Progress ; Money and Prices. 
MouLTON, H. G., The Financial Organization of Society (1921). 
Pratt, S. S., The Work of Wall Street. 
Scott, W. A., Money and Banking. 

Smith, A., Wealth of Nations (Books II, IV, Chap. III). 
White, H., Money and Banking (Parts I and II). 



CHAPTER XXII 

CHANGES IN THE VALUE OF MONEY OR THE 

LEVEL OF PRICES AND THEIR 

MEASUREMENT 

CHANGES IN THE VALUE OF MONEY AND PRICE LEVELS 

We now come to a subject of intense practical importance 
and one which during the last few years has been of much public 
interest. We have before referred to the fact that the value of 
money, the standard of all other values, is itself subject to change 
and that its fluctuations vary inversely with changes in the level 
of prices. The term ''value" is used here in a general sense de- 
noting the abstract relationship existing between money and all 
other commodities. Strictly speaking, money has many values. 
No one commodity does for money what money does for all 
others in its capacity of a standard of value. In the economic 
world, there is one accepted measure of value for each and every 
commodity, one specific relation which denotes the general re- 
lation which each good bears to all others, which gauges its 
standing in the market, namely its money price. But no one 
other commodity serves as a measure of the value of money. 
Money has, of course, as many separate values as there are com- 
modities offered for sale, the other side of every price quotation 
expresses a value of money. If wheat is quoted at $1 a bushel, 
the value of a dollar in terms of wheat is one bushel. But if 
wheat goes up to $1.25 a bushel though the value of money in 
terms of wheat has fallen, one dollar only commanding in ex- 
change four-fifths of a bushel, it does not necessarily follow that 
the value of money in relation to all other commodities has 
fallen. The rise may and is usually taken to indicate an in- 
crease in the value of wheat. If, however, the prices of other 
commodities have gone up, the higher price of wheat may be 

259 



260 PRACTICAL ECONOMICS 

due to a fall in the value of money. In this case the value of 
wheat in reference to other commodities will remain the same 
but the value of money, the purchasing power of a dollar, will 
have shrunk. If all prices were to rise 25 per cent, it is evident 
that a dollar would only purchase four-fifths of what it would 
before, that is, its value would decrease one-fifth or 20 per cent. 
Changes in the value of money would thus be registered by in- 
verse changes in the general level of prices. But prices never 
rise and fall alike. They are most chaotic in their changes; 
some fluctuate violently from day to day; others steadily rise 
or fall for long periods and some scarcely vary at all. But 
though some go up and some go down and others change but 
little, the general level of prices is always tending up or down. 
The problem is to measure these movements of the general level 
of prices, a problem which is solved by a device called an index 
number, the invention of an Italian by the name of Carli, in 1750. 

THE SELECTION OF COMMODITIES FOR AN INDEX 

NUMBER 

An index number is simply a summary in some form of the 
price changes of a selected set of commodities, used as the name 
suggests, to indicate changes in the level of prices in general. 
It serves somewhat the same purpose as the water gauge of a 
boiler, the visible rise or fall of which denote changes in the in- 
visible level of the water within. 

In constructing such an index the first consideration is to select 
a set of sample commodities, the price changes of which will 
fairly represent those of commodities as a whole. If all com- 
modities fluctuated alike changes in the prices of a few selected 
at random would accurately reflect price changes as a whole. 
But as all commodities do not fluctuate alike and are not all 
of the same importance as elements of the general system of 
prices, the value of an index number as a reliable indicator of 
changes in the general price level will depend in the first place 
on whether it is based on a carefully chosen representative list 
of commodities. 

Prices of commodities tend to move in groups. And it is the 
presence of these groups of commodities whose prices advance 



155 



150 



145 



UO 



135 



130 



125 



120 



115 



110 



105 



100 



95 



90 



85 



80 



CHANGES IN THE VALUE OF MONEY 261 

'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 "11 'IZn.S 

155 
150 
145 



— 


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'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 'GO '01 '02 '03 '04 '05 '06 '07 '03 '03 '10 '11 '12 '13 
Fig. 15. — Index Numbers of the Prices of 19 Mineral Products and of 18 

Farm Crops. 



262 PRACTICAL ECONOMICS 

or fall in harmony, that constitutes a source of danger to index 
numbers. The prices of raw materials tend to move together 
and may be distinguished as a class from manufactured goods. 
Again raw materials may be subdivided into several groups of 
products with closely related prices, such as minerals, forest, 
animal and farm products. Manufactured goods may also be 
divided into two groups which behave quite differently, namely 
producers' goods and consumers' goods, the former including all 
articles bought for business use, the latter those purchased di- 
rectly by consumers. Some of these groups are interrelated and 
at times move in unison, as in the case of raw materials and the 
partly finished or finished products made from them. Others 
differ widely in the degree in which they fluctuate or move in 
entirely opposite directions as the accompanying chart of farm 
and mineral products show. 

It is very evident then that an index number based on an undue 
quantity of any one or two of these groups will not represent 
prices as a whole and might by being confined to a particular 
clique grossly misrepresent them, a possibility that those who 
read index numbers published in the United States purporting to 
gauge changes in the general level of prices, might do well to bear 
in mind. Chart 16 on page 263 of two index numbers, the one 
based on miscellaneous commodities, the other on food products, 
bears testimony to this fact. 

It will be noticed that the food index flatly contradicts the gen- 
eral commodity index in 1890-1892, 1900 and 1901, etc. Such 
contradictions are due chiefly to contrasts in those years between 
business conditions and harvest conditions. A food index made 
up for the most part of farm products, animal products and partly 
finished products produced from them, on account of its suscep- 
tibility to seasonal harvest conditions is very apt to give a wrong 
impression of prices in general. 

PRICE DATA 

Just as important as selection of the commodities that go 
to make up the index is the securing of accurate price quota- 
tions; on these the reliability of the index numbers rests. As 
a rule wholesale market prices are chosen. Representative re- 
tail prices are difficult to obtain owing to local variations, though 



CHANGES IN THE VALUE OF MONEY 



263 



several retail indexes are now published here and abroad. The 
price quotations for a particular date, such as the first of the 
week or month may be taken or an average price may be struck 
from a number of quotations. 



•90 '91 '92 '93 '94 '95 '96'97 '98 '99 '00 '01 '02 '03 •04'05 '06 '07 '08 '09 '10 •iri2'13 



150 



140 



135 



130 



125 



120 



115 



110 



105 



100 



96 



90 



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'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 *03 '04 '05 '06 '07 '08 '09 10 'U '12 '13 

Fig. 16. — Index Numbers of the Prices of 25 Food Products and of 25 
Miscellaneous Commodities. 

METHODS OF COMPUTING 

Various methods are employed to manipulate these prices to 
gauge changes in the general price level. A simple illustration 
of each of the three chief methods will suffice to make clear the 



264 PRACTICAL ECONOMICS 

nature of index numbers and enable us to read any one with 
some appreciation of its significance as well as its limitations. 
The crudest method of all is to add the actual prices of the 
selected commodities for each period to be investigated and 
compare their sums. Let us assume that the prices of wheat, 
currants, opium and pig iron for 1900, 1901, and 1902 were as 
follows : 

Table 1. — Aggregate Prices 
Commodity Unit 1900 1901 1902 



Wheat, 


Bu. 


.80 


.85 


1.40 


Currants, 


Lb. 


.10 


.15 


.13 


Opium, 


Lb. 


6.00 


7.50 


6.20 


Pig Iron, 


Ton 


16.00 


17.50 


18.00 



Aggregate Prices, 22.90 26.00 25.75 

A comparison of the ''aggregate prices" shows that the cost of 
the four commodities rose in 1901 and fell slightly in 1902. This 
method of gauging changes in the general price level by adding 
the actual prices of such incongruous units as pounds, bushels, 
tons and ounces is subject to great inaccuracies. A relatively 
small change in a high priced unit such as opium exerts more 
influence on the total than a relatively great change in a low 
priced but important unit such as wheat. In the above table 
for example, the 22 per cent drop in opium exerts almost three 
times the influence on the aggregate price for 1901, as does the 
69 per cent rise in wheat. And even if as it is sometimes done, 
the various units are all reduced to one quantity such as pounds, 
this distortion still exists. 

To avoid these inaccuracies the actual prices are turned into 
"relative prices" on the basis of 100. By "relative price" is 
meant the percentage the actual price of a commodity at any 
period is of its actual price at a given period chosen as a base 
from which price fluctuations are to be measured. All prices 
of commodities at this base period will, therefore, be represented 
by 100, and all changes will be expressed as relatives of 100; 
a rise of 10 per cent being recorded as 110, a fall of 10 per cent 



CHANGES IN THE VALUE OF MONEY 265 

as 90. For example, if we take 1900 as the base year in the 
table above to find the relative price of wheat for 1901, we 
simply divide the actual price 85 cents by the base price 80 cents, 
multiply the quotient by 100 which gives us 106. The price of 
wheat in the base year will be represented by 100 and in 1901 
by 106, showing a rise of 6 per cent in the price of wheat. The 
following table gives the relative prices of the four products 
using the year 1900 as the base period. 

Table II. — Relative Prices 
Commodities Units Base 1900 1901 1902 



Wheat, 


Bu. 


100 


106 


175 


Currants, 


Lb. 


100 


150 


130 


Opium, 


Lb. 


100 


125 


103 


Pig Iron 


Ton 


100 


109 


113 



Sums, 4)400 4)490 4)521 

Index Number 

(Arith. Average) 100 123 130 

By adding these relative prices for each period and dividing 
by their number the final index number is found which is thus 
the simple arithmetical average of the relative prices of the 
commodities taken. In the above table 100 of course represents 
the average of prices in 1900, while the index numbers for 1901 
and 1902 show there has been an average rise in the prices of 
all the commodities taken of 23 per cent and 30 per cent, re- 
spectively. 

Other methods of averaging are sometimes employed. The 
geometric mean used by Jevons gives a more accurate average 
in that it protects the index number from being unduly influ- 
enced by extreme variations in the prices of a few articles; 
medians are sometimes preferred for the same reason. The 
most common method, however, is that of the simple arithmetic 
mean illustrated above. 

In distinction to a ''simple" index number based on the single 
price of each article included such as just described is a 



266 



PRACTICAL ECONOMICS 



"weighted" index number, wherein the price of each commodity 
is multiplied by some number to accord it, an influence on the 
result in proportion to its economic importance. There are 
many methods of ''weighting;" to illustrate the principle, we 
will describe that used by the U. S. Bureau of Labor Statistics 
in computing the index now currently published in their monthly 
bulletin. According to this system, the economic importance of 
an article is expressed by the value of the total quantity ex- 
changed in a given year. The index is constructed by multiply- 
ing the price of each article at each period by the estimated 
quantity exchanged and adding these weighted prices to obtain 
the aggregate weighted price or the total value in exchange of 
all the 'commodities at each period. The final index number 
which tells at a glance the percentage of rise or fall in the price 
level is obtained by dividing the weighted total of each period 
by the base total. The following table illustrates the process. 
Instead of using the exact figures, the assumed quantities and 
values of the articles entering into exchange are expressed in 
round millions. 







Table III 


. — Weighted Prices 








Unit 


Base 1900 


1901 


1902 


Com- 
modity 


Quantity 
Price exchanged Weighted 
used as price 
weight 


Quantity 
Price exchanged 
in 1900 

weight 


Weighted 
price 


Quantity 
Price exchanged 
in 1900 
weight 


Weighted 
price 


Wheat, 
Currants, 
Opium, 
Pig iron. 


Bu. 
Lb. 
Lb. 
Ton 


Millions Millions 

S.80X 735 = $588 

lOX 32 = 3 

6.00X 1 = 6 

16.00X 8 = 128 


Millions 

$.85X 735 

.15X 32 

7.50X 1 

17.50X 8 


Millions 

= $624 

5 

7 

= 140 


Millions 

$1.40X 735 = 

.13X 32 = 

6.20X 1 = 

18.00X 8 = 


Millions 

= $1029 

4 

6 

144 


Aggregate weighted prices, $725 
Index numbers (relative prices 

1900 base period), 100 


$776 
107 


$1183 
163 



The object of weighting is to prevent the index number being 
unduly influenced by changes in the prices of unimportant com- 
modities and to accord to the great staples a position on the 



CH4NGES IN THE VALUE OF MONEY 267 

index equivalent to that which they occupy in the system of 
actual prices. It is obvious that opium and currants do not ex- 
ert an influence on the general level of prices equal to that of 
wheat and iron. The simple index number in the year 1901, 
under the influence of currants and opium, soars way up while 
the following year tricked by a fall of the same insignificant 
pair, it fails to do justice to the rise in wheat and iron. The 
weighted index number corrects these maladjustments toning 
down the exaggerated rise in 1901, and by giving the great 
staples, wheat and iron, power in proportion to their economic 
importance, registers a more significant advance in the price 
level. 

For the sake of making clear the principle, we have somewhat 
exaggerated the difference in the results obtained from the use 
of weighted and simple index numbers. When a larger number 
of commodities are taken the influence of extreme increases or 
decreases in the more unimportant commodities are apt to be 
lessened by one neutralizing the other: such an index tends 
to weight itself, though "haphazard" weighting of this character 
may, and often does, result in a viciously weighted index. 
Weighting is sometimes attained in a simple index number by 
causing an important commodity, such as wheat, to be repre- 
sented indirectly several times by including two kinds of wheat, 
four of flour, bread, biscuits, etc. While actual tests made by 
comparing weighted and simple index numbers show a fairly 
close agreement, both pointing out equally well the general 
trend of prices, there seems to be a growing opinion among 
experts, both in this country and abroad, that an index number 
based on a large number of carefully selected commodities 
weighted in accordance with their economic importance will 
reflect changes in the general level of prices with greater ac- 
curacy; and such a conclusion seems sound. 

BIRD'S-EYE VIEW OF PRICE CHANGES IN UNITED 
STATES FROM 1840-1920 

There are five Index Numbers of wholesale prices pub- 
lished currently in the United States; Dun's, Bradstreet's, Gib- 
son's, The N. Y. Times Analyst, and that of the United States 



268 PRACTICAL ECONOMICS 

Bureau of Labor Statistics, based on 297 quotations of 201 dis- 
tinct commodities weighted as described above. Through the 
courtesy of this department, we are able to present the following 
table of prices covering the years from 1840 to 1920. This in- 
dex number is an amalgamation of that of the United States 
Senate Finance Committee, running from 1840 to 1890, with the 
current index of the Bureau of Labor Statistics which commences 
at the year 1890. The Senate Committee's, or Falkner's Index as 
it is sometimes termed, is a simple index based on the whole- 
sale prices of over 223 articles. Both indexes have been re- 
duced to a common base, prices in 1913 equalling 100, and are 
consolidated at the year 1890. 

Table IV. — Index Number of Wholesale Prices 1840-1921 









1913 = 


= 100 








1840 


103 


1861 


88 


1882 


95 


1902 


85 


1841 


102 


1862 


103 


1883 


93 


1903 


85 


1842 


95 


1863 


130 


1884 


87 


1904 


86 


1843 


89 


1864 


167 


1885 


82 


1905 


85 


1844 


89 


1865 


190 


1886 


81 


1906 


88 


1845 


90 


1866 


168 


1887 


81 


1907 


94 


1846 


93 


1867 


151 


1888 


83 


1909 


91 


1847 


93 


1868 


142 


1889 


83 


1909 


97 


1848 


89 


1869 


135 


1890 


81 


1910 


99 


1849 


87 


1870 


125 


1891 


81 


1911 


95 


1850 


90 


1871 


119 


1892 


75 


1912 


101 


1851 


93 


1872 


122 


1893 


77 


1913 


100 


1852 


90 


1873 


121 


1894 


69 


1914 


100 


1853 


96 


1874 


117 


1895 


69 


1915 


101 


1854 


99 


1875 


112 


1896 


66 


1916 


124 


1855 


99 


1876 


104 


1897 


66 


1917 


176 


1856 


99 


1877 


97 


1898 


69 


1918 


196 


1857 


99 


1878 


89 


1899 


74 


1919 


212 


1858 


86 


1879 


85 


1900 


80 


1920May272 


1859 


88 


1880 


94 


1901 


79 


1921 


153 


1860 


88 


1881 


93 











The following chart presents this index number in graphic 
form and makes clear at a glance the upward and downward 
swings of prices during the last eighty years. The index num- 
ber indicates that the general level of prices in May, 1920, was 
172 per cent higher than in 1913, which would signify that the 



CHANGES IN THE VALUE OF MONEY 



269 



value of money in the United States has depreciated 63 per 
cent, a dollar in 1920 being equivalent in purchasing power to 
37 cents in 1913, so far as wholesale prices are concerned. 



•40 '45 '50 '55 '60 '65 '10 '75 



'85 '90 "95 '00 '05 '10 'lo '20 '25 



2tJU 
2G0 
210 
220 








■„. 


ex ] 


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aer c 


f W loles 


ale 1 


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180 
160 
110 
120 
































/ 














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fid 


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'40 '45 '50 '55 '60 '65 '70 



•75 '80 '85 '90 

Fig. 17 



'95 '00 '05 '10 *15 '20 '25 



The following tables and chart prepared by the U. S. Bureau 
of Labor Statistics, throw considerable light on changes in the 
cost of living from 1907-1920. 

RELATIVE RETAIL PRICES OF 22 ARTICLES OF FOOD 

In Table V the average monthly and yearly prices of 22 food articles 
are shown as relative prices, or percentages of the average prices for 
the year 1913. These relatives are computed by dividing the average 
price of each commodity for each month and each year by the average 
price of that commodity for 1913. Relative prices must be used with 
caution. For example, the relative price of pork chops in November, 
1919, was 200, which means that the money price was 200 per cent of 
the money price in 1913, or, in other words, the price doubled. The 
relative price of pork chops in December, 1919, was 181, showing a 
drop of 19 points from 200, which is a decrease of only 9.5 per cent. 

In the last column of this table are given index numbers showing 
the changes by months and years in the retail cost of the 22 food articles 
weighted according to the importance of each article in the consump- 
tion of the average family. Prices are obtained each month for 43 
food articles, but only 22 of these are included in the retail food price 



270 



PRACTICAL ECONOMICS 






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CHANGES IN THE VALUE OF MONEY 275 

index, because the amounts consumed by the average family have been 
obtained as yet for only these 22 food articles. These articles comprise 
about two-thirds of the entire food budget of the average family and 
reflect with great accuracy changes in the cost of the food budget. The 
figure representing the cost of these 22 food articles was 193 in Novem- 
ber and 178 in December. This shows that during the month from 
November to December there was a decrease of 8 per cent. 

The curve shown in the chart pictures more readily to the eye the 
changes in the cost of the family market basket and the trend in the 
cost of the food budget than do the index numbers given in the table. 
The decrease in the cost of these articles since July brings the curve 
down in December to the point where it was in September, 1918. The 
chart has been drawn on the logarithmic scale, because the percentages 
of increase or decrease are more accurately shown than on the arith- 
metic scale.* 

TEST QUESTIONS 

1. What is an index number? 

2. Why would an index number based on farm products not be satis- 
factory as an indication of rises and falls in the general level of prices? 

3. Construct an index number based on the relative prices of six com- 
modities, using 1913 as the base year. 

4. What is a iveighted index? 

5. In what year did wholesale prices reach the top of their rise after the 
world war? 

* Monthly Labor Reviexv, February, 1921. ' 



CHAPTER XXIII 

CAUSES AND EFFECTS OF PRICE CHANGES AND 
FOREIGN EXCHANGE 

CAUSES OF CHANGES IN THE VALUE OF MONEY OR 
LEVEL OF PRICES 

In order to gain an insight into the causes of price changes, the 
first point to notice is that they are the resultant of two dis- 
tinct groups of forces. A price is an expression of the exchange 
relation existing between two things, money and a commodity. 
An index number or relative price expresses a change in the 
relation that exists between money and commodities in general, 
and such a change may be brought about by causes directly 
affecting money or by those influencing commodities; or by the 
combined action of both. 

The value of money is determined as is the value of all other 
things, by the supply of it in relation to the demand for it. 
Now the demand for money arises from the commodities that 
are to be exchanged. At any given price level an increase in 
the number of commodities to be exchanged involves an increase 
in the demand for money. Changes in the value of money or the 
level of prices will, therefore, be brought about by causes on the 
one hand that operate to increase or decrease the supply of 
money and on the other by causes increasing or decreasing the 
volume of trade or the number of exchanges to be transacted 
through the agency of money. 

INFLUENCE OF THE SUPPLY OF MONEY ON THE PRICE 

LEVEL 

In considering the supply of money, we must take into ac- 
count not only the quantity of money, namely gold, but also the 
amount of supplementary money and deposit currency, changes 
in the quantities of which are in effect equivalent to changes in 
♦ 276 



CAUSES AND EFFECTS OF PRICE CHANGES 277 

the supply of money. An increase in deposit currency, for in- 
stance, since it affects exchanges as readily as money itself, will 
be tantamount to a decrease in the demand for money or from 
our present point of view, to any increase in the supply of 
money. We must also allow for the rapidity of their circulation. 
It is evident that if in a given period ten million exchanges are 
to be made at a dollar a piece, ten million dollars will be re- 
quired if each dollar is used only once, but if each dollar is 
used five times, two million dollars will suffice to do the work. 
In any given day, week or month in actual life, the same money 
is being used several times over. The average number of times 
money is used in a given period is termed its rate of turnover 
or rapidity of circulation. An increase in its rapidity of circu- 
lation is thus equivalent to an increase in its supply. 
■ The quantity theory of money, a veritable bone of contention 
among economists, stated in its strictest form, asserts that the 
value of money, other things being equal, varies in a ratio ex- 
actly inverse to its supply: ''Supply" meaning the quantity of 
standard money or gold. The number of "other things," how- 
ever, is so large and their likelihood of remaining equal so un- 
likely that a broader statement is perhaps more apt to be de- 
scriptive of actual facts. If all exchanges in a country were 
made with gold and the price level were suddenly doubled so 
that two-cent stamps cost four, nickle articles a dime and so 
on, it would be true that everybody would need just twice as 
much money to make the same purchases. Such a doubling of 
prices could not possibly occur without a doubling of the money 
supply. In the same manner were the money supply of the 
country suddenly doubled, prices would rise a hundred per cent ; 
or were the quantity of money to be reduced one-half, to effect 
the same number of exchanges, prices must be reduced one- 
half. In actual affairs, however, an increase in the supply of 
gold does not affect prices in the simple and direct way indicated 
above, but in a roundabout and indirect manner, by wending 
is way into circulation or swelling the reserves of the banks, 
their capacity to loan and finally increasing the currency. In 
the meantime "other things" may intervene, exaggerating or 
nullifying its effects; a development of the banking system by 



278 PRACTICAL ECONOMICS 

extending the use of credit or a business boom by expanding 
credit may magnify its results; a contraction of credit or an 
increase in the volume of trade due to industrial progress may 
negative it. A more moderate statement that squares with the 
facts would be that an increase in the supply of money or any 
increase in the currency tends to decrease the value of money 
or raise the level of prices. 

The effect of an increase of gold on prices is clearly seen 
in the general rise in prices that took place the world over fol- 
lowing the gold discoveries in 1848 and 1849 in Australia and 
California; discoveries which increased the annual output of 
gold from $40,000,000 in 1850 to $150,000,000 in 1853. Saur- 
beck's iiidex registers a rise in the period between 1852 and 1873 
of 38 per cent in English prices. In this country of course the 
rise was accentuated by causes affecting the other side of the 
price equation, due to the influence of the Civil War on com- 
modities. A second period which illustrates the effect not only 
of an increase in gold, but also of a more than proportionate 
increase in the quantity of the other forms of currency based on 
gold, dates from 1896 when the price levels of the great nations 
of the world advanced in unison. In the early nineties gold 
production took another sudden leap ahead, the world's output, 
increasing from 200 tons in 1890, to 700 in 1910. In addition 
to the increased supply of gold, particularly in the United States, 
the rapid strides made in the. development of the banking and 
credit systems resulted in an increase of credit currency based 
on gold, especially in the form of deposit currency. In spite 
of the extension of trade occurring in these periods the net re- 
sult was a world-wide increase in prices. 

DEMAND FOR MONEY OR THE VOLUME OF TRADE 

Quite apart from causes which influence prices on the money 
side are those which affect them from the commodity side. At 
any given price level, an increase in the volume of exchanges 
to be transacted will tend to lower prices by increasing the de- 
mand for money; conversely a falling off in the volume of trade 
or the total number of exchange transactions is the product of 
the number of commodities multiplied by their rate of turn- 



CAUSES AND EFFECTS OF PRICE CHANGES 279 

over. Many and varied are the influences that play upon the 
volume of trade. Chief among those tending to increase the 
number of exchanges and lower prices are science, invention, 
development of transportation, labor saving machinery, division 
of labor, improved processes of production and organization and 
increases in the population. On the other side we have wars, 
monopoly, high tariffs, strikes, etc. 

The fall of prices that occurred among the great nations of 
the world between 1873 and 1896, is generally conceded to have 
been caused by the fact that the volume of trade stimulated 
by the remarkable advance of industrial progress, increased at 
a more rapid rate than did the supply of money. The late 
abnormal rise in the price levels the world over was due to just 
the opposite situation, — to the shortage of commodities fol- 
lowing in the train of the world war with its destruction of 
wealth and withdrawal of labor from the usual channels of 
production, accompanied also as in most wars by an artificial 
expansion of credit. 

To sum up, there are two direct causes of price changes, the 
supply of money or the total volume of currency and the total 
number of commodities to be exchanged or the volume of trade. 
All forces influencing prices may be divided into two groups 
according as they work through one or the other of the above. 
Action and reaction occur between these two causes; an in- 
crease in the supply of money for instance may and usually does 
result in an increase in trade; and action and reaction may 
take place between these two causes and the result. The supply 
of money and the volume of trade may both be influenced 
by changes in the price level, the result in its turn becoming 
the cause. 

EFFECTS OF CHANGES IN THE VALUE OF MONEY OR 

PRICES 

While it matters little whether prices are permanently high 
or low, the difference involving merely a greater or fewer num- 
ber of counters with which to effect the exchanges of wealth 
rising or falling prices are of considerable moment. Any change 
in the standard which serves as a measure of values is bound 



280 PRACTICAL ECONOMICS 

to result in disturbing effects. And though such changes in nor- 
mal times may take place but slowly, the modern set toward 
long time production and long term contracts renders them par- 
ticularly undesirable. In a period of rising prices the debtor 
gains at the expense of the creditor, for though he pays the 
stipulated sum of money, his creditor receives less purchasing 
power, or value in turn of commodities. In this situation, land- 
lords whose land is let on long leases, holders of mortgages of 
bonds, depositors in banks who withdraw their money after a 
number of years, are the losers. A man who in January, 1920, 
drew $100 out of a savings bank in which he had deposited it in 
1913, would receive a sum of money equivalent in purchasing 
power tP about $40 of his original deposit. In periods of fall- 
ing prices the reverse is true, the creditors gain at the expense 
of the debtors. 

But the most disturbing effects of price changes occur in the 
field of distribution, where they play fast and loose with the 
incomes of the people, enriching some and impoverishing others. 

A rise in the price level is detrimental to all who derive their 
incomes from fixed interest securities and to those in business 
whose expenses increase with the rise in prices, but who are 
unable to increase their charges such as railways, street car 
companies and public utility concerns. Wage earners as a 
class suffer, as wages do not advance as rapidly as prices. 
Among wage earners, those whose remuneration is fixed by law 
or custom such as teachers and government employees, and the 
salaried class generally whose stipends are relatively stable, are 
the worst sufferers. On the other hand falling prices usually 
mean an increase in the real wages of the workers, as they dis- 
play as a class more stubbornness in resisting a cut than skill 
in securing an advance. Business men as a class benefit by 
rising prices, which to them are synonymous with rising profits. 
Raw materials are usually contracted for in advance and a rise 
in the price of the finished product means an extra profit. As 
the wages of labor lag behind, commodity prices, those en- 
trepreneurs whose costs consist for the most part of wages, reap 
the largest profits; labor's loss is their gain. When prices are 
advancing all along the line, particularly if there is an acute 



CAUSES AND EFFECTS OF PRICE CHANGES 281 

shortage of commodities such as existed during the post-war 
period, the game is largely in their hands and judging by the 
income tax returns, they did not neglect their opportunity. 

A period of falling prices is, for reasons reverse to the above, 
apt to entail losses to the business class generally. There is 
no doubt that business men the world over hate falling prices, 
though as far as the country at large is concerned a period of 
falling prices due to industrial progress may mean the greatest 
good for the greatest number. The psychological effect, how- 
ever, of a rise in the price level on the entrepreneur class, stim- 
ulating business enterprise as it no doubt does, benefits the whole 
community even though the builders do feather their own nests 
first. 

FOREIGN EXCHANGE 

While the buying and selling of commodities within a country 
is carried on in terms of the standard money of the realm, trade 
between one nation and another may be transacted in terms 
of the money of either and involves an exchange of the money 
of the one in terms of the money of the other. If an American 
importer buys a bill of goods from a London merchant the 
purchase might be made in terms of dollars or pounds, though 
custom and convenience both favor the latter. Let us suppose 
the bill amounts to £1,000. Our importer could actually ship 
sufficient American gold dollars or bullion to be coined into one 
thousand sovereigns in London and thus discharge his debt. 
Owing to the expense and inconvenience he will be more likely 
to purchase from his banker a draft on London for £1,000, that 
is, a claim to the payment of pounds sterling in London which 
he mails to his English creditor. Such a transaction, strictly 
speaking, consists of the exchange of a claim to American 
dollars payable in the United States for a claim to English 
pounds payable in England. By "foreign exchange" is meant 
the exchange of the money of one country for that of another. 

THE PAR RATE OF EXCHANGE AND THE GOLD POINTS 

The question is how many dollars should the American pay 
for the £1,000, or what determines the rate of exchange between 



282 PRACTICAL ECONOMICS 

the two moneys? Were it merely a matter of exchanging gold 
dollars for gold sovereigns the answer would be easy, for there 
is 4.866 times the quantity of fine gold in an English pound 
sterling as in an American dollar. One sovereign, as the Eng- 
lish coin is called, would be worth $4,866, and one thousand 
would be worth $4,866 plus. But the American dollars lie on 
one side of the Atlantic, the sovereigns on the other, and to 
ship them across costs both in time and money. The importer 
will prefer to purchase a draft, providing the rate or price per 
pound sterling does not exceed $4,866 plus what it would cost 
him to ship the actual gold which includes freight, insurance, 
loss of interest in transit, etc., amounting to, perhaps, two cents 
on each ^ound sterling. Should, however, the price of "sterling 
exchange" rise above this point of $4,866, importers and others 
having debts to pay in London will find it cheaper to ship 
gold. 

Likewise, if the rate falls below $4,866 the "par of exchange" 
as it is termed, by an amount exceeding the cost of transporta- 
tion, exporters and others having claims against Englishmen 
entitling them to the payment of pounds sterling in London will 
find it cheaper to have the gold coins shipped over here and 
turned into American dollars, than to sell their claims at such 
a low rate. Suppose, for instance, an American exporter has 
sold a bill of goods to an English concern for £1,000. He might 
in the usual course draw a draft or bill of exchange as it is 
termed on his English customer for £1,000, which he would sell 
to his banker at the current rate. But should the rate for such 
bills of exchange be below $4,846 plus, it would pay him to have 
the actual gold shipped over, for after deducting the cost of 
transportation, etc., which would amount to about $20, he would 
receive $4,846. 

These two points in the rate of foreign exchange above or 
below which it becomes profitable to ship gold are termed the 
"gold points" or ''specie points." In normal times the rate of 
exchange will not rise above or fall below them. In actual 
affairs the shipping of bullion is not likely to be done by ex- 
porters but by international bankers and bullion dealers who 
make a practice of buying and selling drafts and bills of ex- 



CAUSES AND EFFECTS OF PRICE CHANGES 283 

change on foreign countries. As the rate rises or falls above or 
below the gold points it becomes profitable for them to ship 
bullion across the Atlantic. By shipping gold, they are able 
to establish their balances in London at a cost of $4,886 plus 
per pound sterling. If they are able to sell drafts on these bal- 
ances in New York, say at $4.89, they make a profit. Conse- 
quently, if the rate of exchange were to rise above $4,886 plus, 
there would arise an unlimited supply of sterling bills, competi- 
tion among the sellers to dispose of them at that price would 
be so keen that the rate of exchange would fall below the upper 
gold point. 

Should the rate fall below $4,846, bankers in New York would 
buy up all the bills possible, send them across, ship back the 
gold to which they entitle, and have it coined into American 
dollars at the rate of $4,866 plus, per pound sterling. Deduct- 
ing the cost of transportation, they would net $4,846 for each 
pound sterling. If they could buy sterling bills on London 
at the rate of $4.83 plus and realize on them at the rate of 
$4.84 plus, there would arise an unlimited demand for sterling 
exchange and the rate would rise. The gold points will, of 
course, vary with freight charges, insurance and interest rates. 

WHAT DETERMINES THE ACTUAL RATE OF FOREIGN 

EXCHANGE 

We have still to discover what causes the fluctuations of the 
rate exchange from day to day, between the gold points. In 
general, it may be said that the rate at which the money of 
our country will exchange for that of another is determined 
by the demand for it in relation to the supply of it. The de- 
mand depends on the indebtedness of all other countries to it; 
the supply on its indebtedness to all other countries, so that the 
relation between demand and supply will depend on the relative 
indebtedness of the given nation to the rest of the world. Should 
the country in question be selling more to foreign countries than 
it is buying from them, the demand for its money will exceed 
the supply and the rate of exchange will rise in its favor; and 
vice versa. 

If, for example, the United States is buying heavily from 



284 PRACTICAL ECONOMICS 

Great Britain, there will arise an urgent demand on the part of 
American importers and others, for drafts and bills of ex- 
change on London with which to pay their debts and the rate 
of sterling exchange in New York will rise. On the other hand, 
should the United States be selling to Great Britain more than 
she is buying from Great Britain, there will be a larger supply 
of bills of exchange in the possession of exporters who have 
claims on Englishmen to sell than there will be a demand by 
importers to purchase such bills, and in consequence, the rate 
would fall. 

The rate of sterling exchange, however, does not depend solely 
on the relative indebtedness of Great Britain and the United 
States, but on their indebtedness to other countries and vice 
versa. Great Britain may be importing more from the United 
States than she is exporting to the States. But in turn, the 
United States may be importing more from Brazil than Brazil 
is exporting to her; while Brazil's imports from Great Britain 
may exceed her imports. As a result of the first condition, there 
would arise in New York an excess of sterling bills on London 
which, however, would be counterbalanced by the demand from 
American importers of coffee from Brazil for sterling bills with 
which to pay their Brazilian creditors. In Brazil these bills 
would be readily purchased by importers to remit to London 
in payment of the manufactured goods they buy from Great 
Britain. Thus the rate for pounds sterling in New York is in- 
fluenced not only by Great Britain's trade with the United States 
but by her trade with Brazil and likewise with all other foreign 
countries. 

Furthermore, in considering the indebtedness of a country, 
account must be taken not only of its recorded exports and im- 
ports but of its ''invisible" exports and imports. Part of the 
trade between nations consists not only of physical commodi- 
ties but of bonds and stocks, interest and dividend payments, 
insurance, banking and transportation. In normal times the 
United States exports more to Great Britain than she imports, 
as far as material commodities are concerned, but Great Britain 
performs certain services for which the United States must pay, 
and which help to swell the invisible imports and thus increase 



CAUSES AND EFFECTS OF PRICE CHANGES 285 

the demand for pounds sterling in terms of which they must 
be paid. For example, the bulk of American freight is carried 
in British ships; London in her position of international banker 
renders services for which Americans among others must pay; 
large sums are remitted annually to British owners of American 
bonds and stocks in the form of interest and dividends ; millions 
are paid in insurance premiums to British companies; services 
are rendered to American tourists abroad whose letters of credit 
add to the demand for sterling exchange; all help to swell the 
invisible indebtedness of the States to Great Britain. Appar- 
ently the "balance of trade" may be against a country, that is 
the recorded imports may exceed the exports when in reality 
the invisible exports may tip the scales in her favor. 

INFLUENCE OF THE MOVEMENT OF GOLD AND CHANGES 
IN THE PRICE LEVEL 

Though for short periods the total exports of a country may 
be either greater or less than its imports, in the long run there 
are world forces at work that tend to make them equal. If a 
country continues buying from foreign countries more than it is 
selling, the rate at which its money exchanges for that of other 
countries will fall, till finally the lower gold point will be passed 
and gold will be exported. By virtue of the connection between 
the quantity of gold and the price level within the country, 
the lessening of the gold supply will result in a lowering of 
prices, while the price level of the countries to which the gold 
has been shipped will tend to be raised. This dual condition 
will discourage imports and stimulate exports and the exchange 
rate will rise. In the case of a country exporting more than 
it is importing just the opposite effect will result. Gold will fin- 
ally be imported, prices will rise, the higher prices within the 
country will attract imports, the comparatively lower prices 
outside will discourage exports, and the balance of trade will 
again be restored. 

Foreign trade is in essence similar to domestic and consists 
of an exchange of commodities and services between nations. 
Payment is effected through the agency of international bankers 
by offsetting contrary claims through the medium of the draft 



288 PRACTICAL ECONOMICS 

or bill of exchange. In a given nation, exporters and others 
in the possession of claims against foreign countries sell these 
claims to importers who use them to cancel claims which other 
nations have against them. When the exports and imports of a 
country are equal, these claims exactly offset each other. When 
they are not equal, one nation will have more claims on other 
nations than they have on it, and gold must eventually be 
shipped in settlement, and gold by its influence on the price level 
tends automatically to rectify the inequality in the balance of 
trade, so that the ebb and flow of the tides of international trade 
are impelled by fundamental laws. Trade between nations as 
between individuals must be based on an exchange of commodi- 
ties and services, no one nation can permanently sell to other 
nations more than it buys, a fair exchange the law ever seeks. 
An understanding of this law makes clear the fallacy involved 
in the theory of a "favorable balance of trade." According to 
this theory it is thought that a nation should sell to other na- 
tions more than it buys from them. It will then have a con- 
tinual stream of money flowing into it as a result of the balance 
in its favor and will thus be permanently enriched at the ex- 
pense of others. Such a situation, however, is a permanent im- 
possibility; it contains within itself the seeds of its own destruc- 
tion, for the continuous flow of money into the country by its 
action on the price level will inevitably check exports, stimulate 
imports and the favorable balance will vanish. 

THE DISCOUNT RATE AND THE RATE OF FOREIGN 
EXCHANGE 

An important factor influencing the supply of foreign bills and 
the exchange rate is the prevailing rate of interest. Capital 
flows to those centers where the price for its use is highest. 
Should interest rates be high in New York, international bankers 
in foreign countries will transfer their loanable funds there. The 
cheapest way to increase their balances in New York is to draw 
drafts on London. These drafts drawn for the purpose of creating 
funds in New York, are termed "Finance Bills." A London 
banker instructs his New York correspondent to draw on him. 
The drafts thus created are sold in New York to importers or 



CAUSES AND EFFECTS OF PRICE CHANGES 287 

others having debts to pay abroad, and the proceeds are loaned 
at the high rate of interest prevailing. This, of course, tends 
to increase the supply of sterling bills and thus lower the ex- 
change rate. Should this condition continue, the rate may 
drop below the lower specie point and gold be imported. There- 
fore, the placing of the discount rate of a country in the hands 
of a central power, such as for years has been the case in Great 
Britain and is now by the Federal Reserve Act in the United 
States, enables a nation to control in a measure its gold supply. 
In the past when gold has flowed out of England in such a 
degree as to endanger the reserves of her monetary system, the 
Bank of England has merely raised the discount rate, capital 
has been attracted, the exchange rate lowered and the importa- 
tion of gold followed. 

WHEN BULLION IS NOT OBTAINABLE 

While under normal conditions the rate of exchange between 
two countries will stay within the specie points, should there 
be an embargo placed on the shipment of bullion or should bul- 
lion for any reason be unobtainable in one country, there is 
no limit to which the exchange rate may not go. Suppose that 
Russia has placed an embargo on the exportation of bullion and 
a Russian importer has purchased a bill of cotton goods from 
Manchester for which he has contracted to pay £1,000. De- 
barred from exporting bullion, his only course, outside of ship- 
ping commodities and selling them in Great Britain for sov- 
ereigns, is to purchase with his paper roubles a sterling bill in 
Petrograd, from a banker or exporter who has a claim on 
someone in London to the payment of pounds sterling. Should 
imports exceed exports, as would likely be the case, he might 
have difficulty in obtaining a bill at all, the demand would 
exceed the supply and the price of sterling bills might rise to 
any height. Such has been the case with some European coun- 
tries since the war, when the rate of exchange for their cur- 
rencies in pounds sterling or American dollars has risen sky high. 
When the free movement of gold or specie is interfered with 
between nations the rate of foreign exchange is determined en- 
tirely by supply and demand and may fall or rise to any height. 



288 PRACTICAL ECONOMICS 

In the case of a country with a depreciated currency or in 
which there is a premium on gold, the rate of exchange will fluc- 
tuate in proportion to the premium on gold. To find the specie 
points there must be added or subtracted from the par rate in 
addition to the expenses of shipment the premium on bullion. 
For example, if the currency of a country owing to an excessive 
issue of paper money had depreciated 50 per cent so that a dol- 
lar bill was only worth one-half a gold dollar, it would take two 
paper dollars to purchase one gold dollar. Therefore, an im- 
porter who had £100 to pay in London; as an alternative to 
purchasing a draft would have to pay 973 paper dollars for the 
486 gold dollars with which to discharge his debt, plus the cost 
of shipment. The upper specie point would be around $9.75. 
Similarly an exporter having a claim calling for the payment 
of £100 in London would not be willing to sell for much less than 
970, for by importing the one hundred pounds sterling he could 
obtain 973 paper dollars which after deducting the expenses 
would net him around $790. The rate of exchange then for a 
country with a depreciated currency will tend to differ from the 
ordinary rate in proportion to the premium on gold. 

TEST QUESTIONS 

1. Under what two heads can causes affecting changes in the general 
level of prices be grouped? 

2. What is the quantity theory of money? 

3. What must be taken into consideration in estimating the quantity of 
money? 

4. What factors tend to increase the demand for money? 

5. Explain the effect of rising and falling prices on creditors and debtors; 
on profits and wages. 

6. What is the "par of exchange"? 

7. Why will the rate of sterling exchange in normal times not rise above 
or fall below the "gold points"? 

8. Where does the demand for sterling exchange spring from? 

9. Where does the supply of sterling exchange spring from? 

10. How does the interest rate influence the rate of exchange? 

REFERENCES 

Barbour, Sir D., The Influence of the Gold Supply on Prices and Profits. 
Cannan, E., Money — Its Connection with Rising and Falling Prices. 



CAUSES AND EFFECTS OF PRICE CHANGES 289 

Clay, H., Economics for the General Reader (Chap. XI). 

Ely, R. T., Outlines of Economics (Chaps. XVI, XVII). 

EscHER, F., Elements of Foreign Exchange. 

FiSKE, G. M., International Commercial Policies. 

Fisher, I., Stabilizing the Dollar; The Purchasing Power of Money. 

GoscHEN, G. J., Theory of Foreign Exchanges. 

Jevons, W. S., Money (1879, Chaps. I-XVI, XXV-XXVI). 

Johnson, J. F., Money and Currency (Chaps. I-VIII). 

Kemmerer, E. W., High Prices and Deflation. 

Laughlin, J. H., Money and Prices. 

Mill, J. S., Principles of Political Economy (Book III, Chaps. VII-X). 

Mitchell, W. C, Business Cycles, "The Making and Using of Index 

Memoirs" (U. S. Bureau of Labor Statistics, Bull. 173). 
Pepper, C. M., Foreign Trade. 

Seager, H. R., Principles of Economics (Chap. XXI). 
Seligman, E. R. a.. Principles of Economics (Chap. XXVIII). 
Smith, A., Wealth of Nations (Book IV, Chap. II). 
Taussig, F. W., Principles of Economics, Tariff History in the United 

States. 
Walsh, C. M., Measurement of Exchange Value (Chaps. Ill, VI-XII). 
Withers, H., Money Changing. 



PART IV 

ANALYSIS OF THE FOUR FORMS OF INCOME 

AND FACTORS DETERMINING THEIR 

AMOUNTS 



CHAPTER XXIV 

THE DISTRIBUTION OF WEALTH 

The term "distribution" in economics refers to the division of 
the "net dividend" or "national income/' among the agents of 
production by whose cooperation it is produced. This net prod- 
uct proceeds in a continuous flow from the channels of industry 
and constitutes the net addition made to the wealth of the nation. 

A SURVEY OF THE FACTS RESPECTING THE INCOME OF 
THE UNITED STATES AND ITS DISTRIBUTION 

The estimation of the net income of a nation is a task of no 
mean order, and however much care is used, the figures will be 
liable to some error. There have been several independent esti- 
mates made recently in the United States which, considering the 
magnitude of the figure, show surprisingly close results. Per- 
haps the most exhaustive and thorough is that recently conducted 
under the auspices of the National Bureau of Economic Re- 
search by Mr. King and Mr. Knauth.'' Two separate estimates 
were made, one by sources of production by Mr. King, who ascer- 
tained the value product of all industries. The value product 
of an industry is the excess of the value of its output over the 
costs of the materials it consumes, including depreciation and 
depletion of resources. The second estimate made by Mr. Knauth 
was by incomes received and was based primarily on income 
tax returns, supplemented by other data on tax-exempt income, 
such as the income of certain classes of tax-exempt bonds, sal- 
aries of state officials, rental values of homes occupied by owners, 
food and fuel produced and consumed directly by farmers. 
These two independent estimates which, when completed, differed 
only by a maximum variation of less than 7 per cent in any 
one year, were then carefully checked against each other and 

^"Income in the United States." For a complete analysis the reaaer is 
referred to this valuable and interesting work. 

293 



294 PRACTICAL ECONOMICS 

made the basis for the final estimate. According to the final 
figures, the national income and the per capita income of the 
United States for the years 1913-18 were as follows: 





National income 


Per capita income 




in billions 


in dollars per annum 


1913 


$34.4- 


S354 


1914 


33.2 


335 


1915 


36.0 


358 


1916 


45.4 


446 


1917 


53.9 


523 


1918 


61.0 


586 



THE PROBLEM OF DISTRIBUTION 

Owing^to the remarkable progress in the arts of industry fol- 
lowing the industrial revolution, the wealth of the great nations 
of the world has been tremendously augmented during the last 
hundred years. Yet at no time has there been more dissatisfac- 
tion evinced concerning the division of that wealth. There 
always has been and probably always will be more or less dis- 
content among individuals over this division, but recently 
class consciousness fostered by organization, both on the 
side of capital and labor, has led to clashes of arms that have 
made even thrones tremble and whole nations cower. It ap- 
pears that while from the social point of view we have been 
fairly successful in the production of wealth, we have not yet 
satisfactorily solved the problem of its distribution. There is no 
doubt but that the major part of the industrial unrest in this and 
other countries arises from a more or less vague sense of dis- 
contentment over the division of the proceeds of industry. Each 
class suspects that the other is getting a larger share than its due. 
Many thoughtful people feel that a more equitable division 
would be desirable. But as to just what is wrong and how it 
should be remedied, there is considerable confusion of opinion. 
Some blame individual greed, others our economic system, which 
they would either remodel or rebuild along many and dubious 
lines; few really understand our present system and have any 
clear idea of just how distribution is determined under it or the 
laws and principles operating within that govern the shares of 
the individual members and classes. 



THE DISTRIBUTION OF WEALTH 295 

By analyzing separately the net income of the more highly 
organized industries of mining, large-scale manufacturing and 
land transportation which produce one-third of the national 
income and wherein the different forms of income are more 
definitely specified and accounted for, the bureau has been able 
to furnish some very suggestive facts in reference to the distribu- 
tion of wealth between "labor and capital." The net income of 
these industries is split into two parts, that going to hired labor 
in the form of wages and salaries on the one hand and that going 
to the owners of property as rent interest and profits on the 
other. In most years 69-72 per cent goes to employees, including 
salaried officials, while 31-28 per cent goes to the owners in 
interest, rents and profits. In 1913 wages and salaries amounted 
to 8,651 million dollars, or 72 per cent of the total net income, 
while rents, interest and profits equaled 3,359 million dollars, or 
28 per cent of the total. In 1918 the former rose to 17,472 mil- 
lion dollars, or 77 per cent of the total, while the latter were 
5,124 million dollars, or 22 per cent of the net income. 

Another interesting question is very decisively answered by 
this analysis, namely, what is the percentage of the total pay roll 
going to salaried officials. It was ascertained that 92 per cent 
of the total payments to employees went to the rank and file of 
manual and clerical workers, which leaves only 8 per cent for 
salaried officials. 

In 1918 the average annual earnings of employees normally 
engaged in the various industries of the nation ranged from $590 
in agriculture to $1,590 in water transportation, while the average 
for all industries was $1,078. 

In their analysis of the distribution among individuals, the 
bureau draws the dividing line between those whose incomes are 
above or below $2,000. This division, it is suggested, serves as 
well as any other arbitrary line to distinguish between the mod- 
estly well-off, who are able to afford at least the comforts and 
conveniences of life, and those who can scarcely be called well- 
to do. In 1910 only one in twenty-five of those gainfully em- 
ployed enjoyed incomes exceeding $2,000 a year. This number 
increased with war times, and probable rose to one and a half 
out of every ten. The fact remains that in this, the wealthiest 



296 PRACTICAL ECONOMICS 

country of the world,, the great majority are not welUto-do. Of 
all those engaged in gainful occupations in 1918, 86 per cent earn 
less than $2,000 per annum. This 86 per cent possess 60 per 
cent of the national income, while the 14 per cent of those for- 
tunate ones whose incomes exceed $2,000 a year enjoy 40 per 
cent of the total wealth produced. 

In view of the wild statements frequently made in connection 
with the unequal division of wealth, the impartial and careful 
analysis made by the bureau into the distribution of the nation's 
income among classes and individuals is particularly valuable. 
A little more than half of the net income is paid as wages and 
salaries to hired labor. This, the bureau points out, is not 
synonynious with the "share of labor." It would be practically 
impossible to ascertain, for instance, in the case of agriculture 
what part of the net products of the numerous small farmers 
should be attributed to their labor, what should be set down as 
interest on their capital, etc. It is possible to secure fairly 
accurate statistics on wages and salaries and so find the relative 
share of the net income of an industry paid to hired labor. This 
varies in different industries with the degree of organization and 
the relative quantities of labor and capital employed. It ranges 
from one-eighth in farming to three- fourths in mining and manu- 
facturing. In farming the percentage of wages is small, owing 
to the fact that the farmer and his family perform a large part 
of their own work. In banking the percentage of net income 
received in the form of wages is also small on account of the 
small proportion of labor employed to capital. In mining and 
manufacturing, where a larger percentage of labor is employed, 
about three-fourths of the net value produced goes to the workers 
in salaries and wages. The percentage for industry as a whole 
is held down by the low percentage of wages paid in farm- 
ing. The figures also bring out the fact that the share of 
the net product going to hired labor varies from year to 
year according to business conditions. It fell with the sudden 
rise in prices in 1914-16, but rose again with the advance in 
wages in 1917-18. In 1918 the workers secured a larger share 
of the net product of industry than in 1909, but not so large 
as in 1913. The value of housewives' services is not included in 



THE DISTRIBUTION OF WEALTH 



297 



the above. Such an estimate must be a matter of conjecture. 
The bureau estimates that, roughly, the value of these services 
in 1918 approximated fifteen billion dollars. 

The bulk of the large increase in income during the war was 
due to the rise in prices. The actual growth of the national 
income is seen better when the figures are reduced to pre-war 
purchasing power and express the value of the incomes of suc- 
ceeding years in terms of the price level of 1913. 





National income 


Per capita income 




in billions 


in dollars 


1913 


$34.4 


S354 


1914 


33.0 


333 


1915 


35.2 


350 


1916 


40.7 


400 


1917 


40.8 


396 


1918 


38.8 


372 



A comparison made with other nations shows that the United 
States leads the world in both the size of its national income 
and the per capita income of its people. In 1914 the figures for 
the leading nations were as follows: 







National 


Per 


Grade 


Country 


Source of 


income 


capita 


of 




estimates 


millions 
of dollars 


income 
dollars 


accuracy 


United States, 


National Bureau of 
Economic Research 


$33,200 


$335 


I 


United Kingdom, 


Bowley, Stamp 


10,950 


243 


I 


Germany, 


Helfferich 


10,460 


146 


I 


France, 


Pupin 


7,300 


185 


II 


Italy, 




3,890 


112 


IV 


Japan, 




1,580 


29 


III 



Grade I signifies estimate not likely to be inaccurate to a greater 
extent than 10 per cent. 

Grade II signifies estimate not likely to be inaccurate to a greater 
extent than 10 per cent. 

Grade III signifies estimate not hkely to be inaccurate to a greater 
extent than 30 per cent. 

Grade IV signifies estimate not hkely to be inaccurate to a greater 
extent than 40 per cent. 

The term "distribution" suggests an arbitrary division of the 
proceeds of industry, and such a course is conceivable. Under a 



298 PRACTICAL ECONOMICS 

system of Socialism, both the production and distribution of 
wealth might be directed by the state, with the shares of the 
different producers apportioned according to the dictates of the 
government. In the opinion of some, this would result in a more 
equitable distribution of the nation's wealth among those who 
have helped to produce it. Various theories of distribution have 
been put forth, either purporting to explain existing conditions 
or ideal states, but in the world as it is, the distribution of 
wealth, though modified by law or custom, by individual pref- 
erence or organized interests, is determined by the laws of value. 
These laws never cease to act, and in modern society all economic 
remunerations are governed by them. 

' Each individual receives his share of the net product of the 
nation's industry in the form of rent, wages, interest or profits. 
Any one individual's income may consist of one or more of these. 
They are, in effect, prices paid for the use of the factors of pro- 
duction to their respective owners. The extent of any one indi- 
vidual's income will depend on the exchange value of the services 
he renders to production as land-owner, laborer, capitalist or 
entrepreneur. The value of any factor of production, whether it 
be a piece of land, the services of a clerk or a machine, is gov- 
erned by the law of supply and demand, as is the value of a 
consumption good. This great law is the key that unlocks the 
problem of the distribution of wealth. A complete explanation 
of the division of wealth among the individual members of 
society will involve an investigation into the conditions of supply 
and demand for each of the factors of production. First, how- 
ever, we will stop to notice a new principle influencing the de- 
mand for the factors of production. 

PRODUCTIVITY OR THE VALUE OF A FACTOR OF PRO- 
DUCTION IN RELATION TO THE JOINT PRODUCT 

Although the demand for land, labor and capital is derived 
ultimately from the valuable commodities which are produced 
by means of them, it proceeds directly from the entrepreneurs 
who coordinate these other factors in productive enterprises. By 
virtue of their ownership and control of business organizations. 



THE DISTRIBUTION OF WEALTH 299 

this class becomes the employer of the other classes. What con- 
siderations, then, govern their demand? 

The desire of a consumer for a consumption good is based on 
the satisfaction of a personal want. But a business man desires 
a piece of land, a machine, or the services of a laborer for the 
purpose of making a commodity or service for sale at a profit. 
Hence while the value of a consumption good to a customer 
depends on the intensity of the desire it satisfies, that of a pro- 
duction good to a business man depends on the extent to which 
it aids him in the making of his product, or, as it is usually 
termed, it ''productivity." The question then arises as to how the 
concern is able to tell just how productive any particular unit 
is. The product is the joint product of a number of widely dif- 
ferent units, — machines, money, men, etc. Is it possible to deter- 
mine definitely what part of a joint result is due to any given 
unit? 

The only practical method of measuring the contribution of 
any given unit to a joint result is to find out how much that 
result is increased by its presence or decreased by its absence. 
The variation in the joint product is, of course, the resultant 
of all the cooperating units, but as it depends on the presence 
or absence of the particular unit, being added when it is present 
and missing when it is absent, in a real sense it is due to that unit 
and may be said to measure its productivity. As the primary 
purpose of every business is to make a profit, the value of the 
aid rendered by any particular member will hinge on the extent 
to which it reduces the joint costs or increases the value of the 
joint product, or both. A purchasing agent, for example, may 
be valuable not only because he facilitates production by having 
the proper quantity and quality of materials on hand at the 
proper time, but because of the amount he saves by watching 
market conditions and purchasing at the lowest figure. A plant 
manager may increase the volume of production or decrease the 
unit cost, or both. In many cases, of course, the work of indi- 
vidual units is so indirect and far removed from the finished 
product that their contribution to the general result must always 
remain a matter of estimate. But whether a matter of estimate 



300 PRACTICAL ECONOMICS 

or exact measurement, it is this contribution to the general re- 
sult that is the basis of the evaluation of any given productive 
unit to a business concern. 

This is the principle determining the demand of the individual 
employer. The highest price he will be willing to pay will be 
governed by the additional value added to his product over and 
above the extra cost. In the case of a machine, allowance would 
have to be made for maintenance, repairs, and interest on the 
capital if the purchase money is to be borrowed. The increase 
in the value of the total product after deducting these extra costs 
would mark the outside limit of the demand price. Just as the 
consumer balances the money cost with the satisfaction he 
expects to derive from the use of the article, so does the entre- 
preneur weigh the cost of the productive factor with the value it 
will add to his product. And this added value marks the outside 
limit of his demand price. 

THE LAW OF DIMINISHING PRODUCTIVITY 

When a number of similar units of any factor of production 
are successively added to a business enterprise the additions 
made to the product, even though they may increase at first, 
finally grow smaller as the supply of units is increased. This 
is a general law that holds true of any joint result obtained by 
the combination of a number of different factors, when the 
amount of those factors may be varied. By keeping all but one 
fixed and varying the quantities of that one, the resultant varia- 
tions in the joint product will finally begin to diminish. We 
have already referred to one phase of this law under the name 
of the law of ''diminishing returns." In that case the fixed factor 
was land, while labor and capital were massed as the variable. 
The law operates just as surely when labor and capital are fixed 
and the quantity of land is varied. And though it applies to 
all kinds of business organizations, perhaps its operation has 
been laid bare in the business of farming as much as anywhere, 
owing to the numerous experiments that have been conducted 
to ascertain more exactly the value of labor or fertilizers to 
crops. In these experiments all of the factors acting on the crop 
are kept constant but one, and the variations due to this one are 



THE DISTRIBUTION OF WEALTH 



301 





Product 


Increase for each 


Manures per acre 


per acre 


add'l 43 lbs. Nitrogen 




bushels 


bushels 


Minerals alone 


18.3 




Plus 43 lbs. Nitrogen 


28.6 


10.3 


Plus 86 


37.1 


8.5 


Plus 129 


39.0 


1.9 


Plus 172 


39.5 


0.5 



accurately measured. Take, for example, the following experi- 
ment carried on at the famous Rothamsted Experimental Farm 
in England to determine the value of nitrogen to the growing of 
wheat: 



Plot 

A 
B 
C 
D 

E 



The fourth column shows the number of bushels of wheat 
added to the joint product by each additional dose of nitrogen 
and gives unmistakable evidence of the operation of the law of 
diminishing productivity in the successively smaller additions 
made to the joint product. Other experiments in intensive culti- 
vation, extra plowing, harrowing, etc., show that additional 
units of labor and capital fall under the same law. 

Such experiments enable the farmer to make a more economical 
combination of his factors of production, to judge better the 
relative amounts of each it is best to use. In increasing his 
crops, he is guided in deciding whether to rent more land or 
cultivate intensively by applying more fertilizers or hiring more 
labor. The effect on the farmers' demand is readily seen. The 
practical effect of all these experiments is to show more exactly 
the value of different quantities of fertilizer, of capital, or of 
labor, or the precise quantity of any one it is profitable to use. 



MARGINAL PRODUCTIVITY AND INDIVIDUAL DEMAND 

The demand of a producer for a number of similar units of a 
factor of production is governed by marginal productivity in the 
same manner as that of a consumer is by marginal utility. Sup- 
pose the following table contains the result of an experiment 
carried out on a farm of one hundred acres. What would deter- 
mine the highest price the farmer would pay per unit for any 
given quantity he would purchase at any given price? 



302 PRACTICAL ECONOMICS 





Fert. 


Total 


Incr. 


for each 


Value at 


Increase at 


Acre 


units 


product 


add'l unit 


$1 bu. 


$1.50 bu. 


A 




11 










B 


1 


19 




8 


% 8.00 


$12.00 


C 


2 


29 




10 


$10.00 


$15,00 


D 


3 


38 




9 


$ 9.00 


$13.50 


E 


4 


44 




6 


S 6.00 


$ 9.00 


F 


5 


49 




4 


$ 4.00 


$ 6.00 



The value of fertilizer to a farmer depends on the value it adds 
to his crops. But the value added depends on the quantity used; 
each added unit resulting in a smaller increase of product. 
Column^ 5 gives the value of the increase for each additional unit 
of fertilizer when wheat is selling at $1 a bushel. The larger 
the quantity he purchases, the smaller he will pay for each unit. 
He would not be willing to give, for instance, more than $9 per 
unit for a supply of three units. Were the price any higher, it 
would not pay him to use three, as the third unit only adds $9 
to his crop. He would only use two; to induce him to purchase 
three, the price must be $9 or lower. To tempt him to invest 
in four units, the price must be $6 or less, as the fourth adds but 
$6 to the value of his crop. The outside price he would pay for a 
supply of four units would be $6, or for three units $9. In each 
case the price he would pay per unit is determined by the value 
added to the crop by the least productive unit of the quantity. 

Or if we assume the price to be fixed, as it is of course in the 
case of fertilizer or other capital goods, we see the quantity he 
would purchase is likewise determined by a comparison of the 
cost with the value added to his product by the marginal unit. 
If fertilizer is $6 a unit, he will not hesitate to apply three per 
acre. He would break even on the fourth. The outside limit of 
his demand would be four, and it would be decided by his com- 
paring the value added by the fourth unit to the price. Just as 
in the case of the consumer, it is the least productive unit that 
signals the buyer to stop. 

Should the price of wheat go up to $1.50, the productivity and 
hence the value of fertilizer will also be increased. Though each 
unit does not add more bushels, it does add more value to the 



THE DISTRIBUTION OF WEALTH 303 

total product. The farmer could now afford to pay a higher 
price for four units or use a larger quantity at the old price of $6. 

MARGINAL PRODUCTIVITY AND TOTAL DEMAND 

The total demand for any particular kind of production good 
or service is the sum of the individual demands for it and depends 
on marginal productivity. Suppose that four farmers, A, B, C, 
and D, find that consecutive units of labor or capital make the 
following increases to the total values of their crops: 

A B C D 

First, $8 $7 $6 $8 

Second, $10 $9 $8 $7 

Third, $9 $8 $6 $5 

Fourth, $6 $5 $4 $3 

If the unit price of the productive factor were $5, A would 
take four, B's outside limit would be four, C would employ but 
three, and the largest quantity D could be induced to hire would 
be three, making a total demand for 14 units. This is the largest 
quantity that would be bought at that price and also the highest 
price at which the whole supply of 14 would be disposed of. At 
any higher price B and C would refuse to purchase their last 
units. They are the buyers of the margin whose purchase is 
necessary to clear the whole supply, and the marginal produc- 
tivity of the productive factor to them determines the highest 
price at which the supply would be purchased in toto. 

PRACTICAL IMPORTANCE OF MARGINAL PRODUCTIVITY 

In order to make clear the operation of the law of diminishing 
productivity and the principle of marginal productivity, we have 
assumed an exactness which is not everywhere found in actual 
affairs. But while it is not always possible to segregate a single 
kind of production good or service and measure the resultant 
variations in the joint product, wherever this is feasible this law 
is seen to be in operation, and the principle of marginal pro- 
ductivity will be found to govern demand. Every business con- 
cern seeks the most economical combination of its productive 



304 PRACTICAL ECONOMICS 

units. In so doing it will employ each particular class up to that 
point where the increase in product due to the last unit just 
covers the additional cost. In every-day practice business con- 
cerns are constantly comparing the relative values of different 
kinds of productive factors, deciding on the advisability of more 
machines or more men, or whether it would not be better to 
install a particular kind of machine or hire a particular man, or 
fire him. The actual form in which this principle is applied by 
them is in buying or hiring one or more or one less units of land, 
labor or capital. The practical question is: Will it pay? And 
this depends on what will be gained or lost by one more or one 
less unit, which unit is the marginal unit. 

The entrepreneur class is the direct source of the demand for 
the factors of production and the judge of the value of their 
services. This judgment may be based on exact figures, or it 
may be a matter of opinion.. Modern cost and efficiency systems, 
personnel work, psychological analyses of the man and the job, 
are all helping to determine more exactly the value of the indi- 
vidual unit to the concern, but there is still lamentable igno- 
rance in this respect. But whether it is a matter of estimate or 
capable of exact measurement, the only practical test for the 
value of any unit of a factor of production to industry is what 
is added to the sum total of wealth by its presence or lost by its 
•absence.., This is a truth that has many practical applications 
to every-day business life. 

MARGINAL PRODUCTIVITY AND THE LAW OF SUPPLY 
AND DEMAND 

It is sometimes said that the value of a factor of production 
is determined by its productivity. This is an exaggeration some- 
what akin to the cost theory, or the utility theory, each of which 
seeks to explain value from one side only; to exalt one of the 
two primary causes at the expense of the other. The two funda- 
mental causes of value are scarcity and utility. In the case of 
the products of industry, cost enters as a secondary cause gov- 
erning scarcity. We also find in the case of the factors of pro- 
duction a secondary cause productivity, which determines their 
utility to the entrepreneur and through that their value to him. 



THE DISTRIBUTION OF WEALTH 305 

One set of causes act on the supply side, the other on the demand 
side, and the market value is determined not by either one, but 
by the interaction of both. In this chapter we have been exam- 
ining the action of one cause operating on the demand side. But 
to prevent undue emphasis, we must not forget the other side of 
the equation. The exchange values of the factors of production, 
rent, wages, interest and profits, are governed just as much by 
scarcity and cost as by utility and productivity. These, acting 
through the law of supply and demand, co-determine the prices 
of all production goods and services under conditions of free 
competition. 

TEST QUESTIONS 

1. What law governs the share of wealth received by each factor of 
production under our economic system? 

2. What principle determines the demand of the employer for any 
factor of production? 

3. Give an illustration of the law of diminishing productivity. 

4. What is meant by marginal productivity? 

5. To what does the equilibrium price of a factor of production tend to 
correspond? 

REFERENCES 

Carver, T. N., Principles of Pohtical Economy (Chap. XXX), Distribu- 
tion of Wealth (Chap. II). 
Clay, H., Economics for the General Reader (Chaps. XII, XXI-XXV). 
Commons, J. R., The Distribution of Wealth (Chap. III). 
Davenport, H. J., Economics of Enterprise (Chaps. IX, X and XXIII). 
Ely, R. T., OutUnes of Economics (Chap. XIX). 
GiDE, C, Political Economy (Book IV). 

King, W. I., Wealth and Income of the People of the United States. 
Marshall, A., Principles of Economics (Book VI, Chaps. I, II and XI). 
Nicholson, J. S., Principles of Political Economy (Book II, Chap. I). 
Ryan, J. A., Distributive Justice. 

Seligman, E. R. a.. Principles of Economics (Book III, Chap. XXIII). 
Smart, W., Distribution of Income. 
Taussig, F. W., Principles of Economics (Chaps. XXXVIII and LIV). 



CHAPTER XXV 

RENT 

ECONOMIC RENT 

By rent is meant in economics that share of the net product 
of industry assigned to owners of land or natural resources for 
the part these play in production. In ordinary parlance rent 
stands not only for the use of land, but also for the capital 
invested' in it. The rent of a farm or store includes a return 
for the use of buildings and improvements as well as the land. 
This usage, like all popular terminology, has a very practical 
basis. For capital invested in land becomes more or less merged 
with the land itself and tends to have its value determined in 
much the same manner as that of land. Indeed, once capital is 
applied to land in the form of improvements, their values be- 
come so fused, especially after a period of time has elapsed, that 
it is scarcely possible to differentiate between them; to tell, for 
instance, what part of the product of a well-cared-for farm is 
due to ditching, draining, fertilizing, etc., and what to the original 
soil. For the purpose of economic theory there are good reasons 
for distinguishing between the two kinds of income, as, indeed, 
there often are in business where the term "ground rent" is used 
to differentiate the payment made for the use of the site. The 
dual return popularly called rent is referred to in economics as 
commercial rent. A knowledge of the operation of law of de- 
mand and supply in determining the value of land is essential if 
we wish to understand how the values of commercial rents are 
determined in every-day life. 

DEMAND FOR LAND BASED ON SURPLUS PRODUCTIVITY 

Land is in demand as a factor of production because by its use 
a product is able to be produced at a profit. The use of land 
♦ 306 



RENT 307 

involves a cost; unless the value of the product exceeds this 
cost, it is evident that no one will be willing to pay for the 
privilege of working the land. The part that nature plays in 
production is to furnish the raw materials, but even though 
she furnishes these free of charge, the use of them in produc- 
tion involves a cost. To go back to the naked facts of existence, 
man depends for the wherewithal to live on the products he 
obtains by his labor on the soil. No matter who owns the 
soil, they cannot exact a share of the joint product of their 
land and another's labor if that joint product is insufficient to 
support the laborer. Even slaves must be fed, and no matter 
what system of distribution prevails, the land must first provide 
subsistence for the laborer or he ceases to exist. The laborer 
thus has a preferred claim on the product by virtue of the 
laws of nature. This is, however, getting down to the very 
bone of existence. In civilized countries man is not satisfied 
with a bare bone existence. With the aid of science, capital 
and organization, he has tremendously increased the produc- 
tivity of his labor and in return for the effort and sacrifice in- 
volved he demands a decent living. He must at least receive 
this or he will not work. This constitutes his supply price, 
based on his costs, which ftiust be received out of the price of 
the product to maintain an adequate supply of his labor. What- 
ever is paid to the owner of the land must be over and above 
this minimum necessary to maintain labor. Now, this is looking 
at production as if it comprised only two factors, and at bottom 
it does. All wealth is produced by man and nature. The other 
two factors are the result of man's effort and sacrifice and 
therefore involve cost. Labor, capital and organization each 
has its supply price, which must be paid to call into being an 
adequate supply. Each of these factors, then, has a preferred 
claim on the joint product which in the long run must be paid 
or its supply diminishes. Land having no cost, has no supply 
price, no minimum on which its supply depends. Viewed in this 
fundamental light, the productivity of land is in the nature of a 
surplus ; the share of the product imputable to land is that which 
remains after a portion equivalent to the costs of the other 
factors has been taken from the total product. Hence the 



308 PRACTICAL ECONOMICS 

demand price for land is the difference between the price of the 
joint product and the supply prices of the other factors. 

Now, it is obvious that land varies in productivity. In the 
United States at the present time there is some land so sterile 
that it does not repay cultivation, some that just repays working, 
and other that brings in a rich return. Land that just repays 
the cost of working it is said to be on the margin of cultivation 
and is called no-rent land. Now, it is at the margin of produc- 
tion that the supply prices of the other factors of production 
are set. Here the price of the produce just equals the costs of 
the producers. As a greater product is able to be raised by the 
same producers for the same outlay on better land, these superior 
lands yield a surplus over cost, which surplus the owner of the 
land is able to exact as rent. The highest price that will be paid 
for the use of any given piece of land is the difference between 
what a given quantity of the productive factors is able to pro- 
duce on it and what the same factors are able to procure on 
marginal land. 

CAUSES OF PRODUCTIVITY 

The two chief causes of differences in the productivity of 
land are fertility and location. Fertility, of course, is used in 
its broadest sense to include not only the quality of the soil, but 
the advantages of climate. The rich, alluvial soils of the Mis- 
sissippi Valley, the light tobacco loams of Lancaster County, 
Pennsylvania, yield a richer product and command a higher 
rent than less favored lands. The kind of crop or the character 
of its minerals have a similar influence on value of land. Loca- 
tion is as important as fertility, but in a different way. Fer- 
tility increases the gross product, location, so far as agricultural 
land is concerned, decreases the cost of operation. Good roads, 
proximity to markets, rail or water transportation are all im- 
portant factors in farming. Of two one-hundred acre farms 
yielding twenty bushels to the acre, if it costs five cents a bushel 
to take the product of one to the market and ten cents to take 
that of the other, the location of the former will be worth $100 
to the owner. 

The values of farms, mines and timber lands are all affected 



RENT 309 

by location, but it is over factory and store sites that it exerts 
its peculiar powers. In the case of factory sites, the suitability 
of the land for building and the quality of the water are con- 
siderations, but the chief factors are accessibility of: (1) Raw 
materials; (2) markets; (3) sources of power; (4) labor supply; 
(5) loanable capital. In deciding on the location of their plants, 
business concerns consider carefully these factors; the proper 
combination gives them a big advantage over less favorably 
situated concerns; the lack of any one, if competition becomes 
keen, may spell ruin. Because certain districts possess the most 
effective combination of these for particular trades, huge indus- 
trial centers spring up, and land becomes exceedingly valuable. 
Pittsburgh became the center of the steel industry on account of 
its proximity to raw materials and fuel, and also to its strategic 
position between the markets of the east and west. Nearby in 
the Connellsville Valley lies the finest bed of coking coal in 
the world. From deep down in the bowels of its surrounding 
hills nature has furnished it until very recently lavish supplies of 
natural gas, the purest of fuels. Its ore it no longer obtains from 
the Alleghenies, but from the Lake Superior region, which today 
is the chief source of supply for the whole country. Cheap water 
and good rail transport facilities still enable Pittsburgh to 
secure the ore for its hungry blast furnaces at reasonable rates. 
The influence of raw materials on location is seen in the erection 
by the United States Steel Corporation of their mammoth plant 
at Gary, where by virtue of its position on the lake front it 
secures its ore supplies by water from the nearby ore fields and 
its coal and coke also by cheap water haul after it has been 
brought by rail to Lake Erie ports. Proximity to cheap power, 
which means lower cost, has increased the value of land about 
Niagara Falls and made that famous natural sight the center 
of a thriving manufacturing community. 

But it is in store and city sites that we see the supreme im- 
portance of location. Here the influence of fertility is nil, while 
that of location is absolute. Which neighborhood, which street, 
even which side of a street a store locates on sometimes means 
the difference between success and failure. Crowds have their 
peculiarities, their favorite corners and walks; crowds mean 



310 PRACTICAL ECONOMICS 

sales, and on sales stores live. Fabulous rents are paid for par- 
ticularly choice positions, a busy corner may command several 
thousand dollars a year more than the same amount of space 
in the middle of the block. Car stops and other points of van- 
tage are eagerly bid for. The pure productivity of space on 
crowded city thoroughfares has only recently been realized in 
this country. One of the most interesting signs of this is the 
tiny storelet with its few feet of window space and the interior 
just big enough for the owner to stand behind the counter and a 
customer in front. The amount of money that filters into these 
diminutive stores and others bordering city streets from the 
stream of human life ceaselessly flowing by makes the gold 
deposited in the beds of Alaskan rivers pale by comparison. Big 
/ents are paid to secure big volume of sales; a big volume of 
sales means lower cost, lower cost means bigger profit. The unit 
margin of profit may be small, but the total profit considerable. 
One of the most important causes of lower costs and bigger 
profits is quicker turnover. This is one advantage of the Tiny 
Tim type of store mentioned above, which turns its capital over 
much more quickly than the average. The rapid turnover of 
some of the big chains, such as the American Cigar Stores Com- 
pany, has opened the eyes of retail merchants as to the possi- 
bilities in this direction; and this, combined with the educational 
work done by some of the big wholesalers, such as Armour & 
Company, is enabling even the small retailer to grasp the ad- 
vantage of bigger volume and quicker turnover. 

Location sometimes means prestige. Fashionable thorough- 
fares like Fifth Avenue, New York, or Bond Street, London, 
furnish an exclusive trade. Often the same hat will fetch a 
higher price in an exclusive establishment on Fifth Avenue than 
in the common garden variety of store on Sixth Avenue. As a 
general rule, though, higher rents do not mean higher prices. 
The small retailer in a back street who claims to sell at a lower 
price because he pays a lower rent or does not advertise is 
usually mistaken. Store sites in busy places act in the same 
manner as advertising to reduce costs by increasing sales. The 
attractive store site, like rich farm land, brings an advantage to 
its user over less favored situations; competition among store- 



RENT 311 

keepers for the superior sites enables the owners to exact the 
difference or part of it as rent. Rent thus appears as a gain to 
owner of the property, due to its superiority over less fortunately 
situated locations, and the rent paid tends to equalize the ad- 
vantages of different sites to the users. We say tends, because, 
as a general rule, the better sites yield more in proportion to 
the rent paid. Not all the superior productivity is absorbed by 
the landlord in every case, though this is the tendency. 

UNIQUE CONDITIONS OF SUPPLY 

But rent is influenced just as much by scarcity as by produc- 
tivity. No matter how productive land is, if there is a super- 
abundance of it no rent would be paid for its use. Among the 
four factors of production land is unique in the fact that the 
absolute supply of it is limited by nature. Each of the other 
factors is capable of increase and normally does increase, but 
the surface of the earth is eternally fixed. The population of a 
country tends to grow, but its extent of the earth's surface is 
fixed by its geographical boundaries. 

But even this evident truism needs to be modified, for while 
the absolute supply of land within a nation may be fixed, the 
available supply at any given time is capable of increase. 
Transportation is the boon by means of which the country has 
been able to open up new supplies of reserve lands. All during 
the nineteenth century as the railroads reached out across this 
vast continent, new lands and resources were continually being 
opened up. Trolley systems and interurban electrics are doing 
the same thing for the cities today, bringing new land into use or 
old land into more productive use, as they radiate from the dense 
centers of populated cities into the open country. But though 
this should be borne in mind in discussing the nature of rent, on 
account of its very practical bearing on land values, the unique 
character of the supply of land in reference to its absolute limi- 
tation by nature should also be clearly grasped, as it exercises in 
the long run considerable influence on the distribution of na- 
tional income. 

The fact already referred to that land has no supply price 
based on cost, is of vital importance to the nation at large. The 



312 



PRACTICAL ECONOMICS 



productive powers of the other agents are stimulated or retarded 
by the payments they receive, it being generally true that any 
increase in the marginal rates of wages, interest or profits tends 
to increase the activity and supply of their respective factors, 
while any decrease lessens them. The fact that the supply of 
land is independent of the price paid to its owners, being neither 
increased by an increase in rent nor decreased by a lowering of 
the payments received by landowners, is one of the foundation 
stones of Henry George's famous "single tax," and has an im- 
portant bearing on taxation. 

NATURE OF RENT ILLUSTRATED 

How i-ent arises and its nature as a surplus above the re- 
turns to the other factors at the margin of production may be 



24 Units Product 



20 Units 



24 Unit Product 
20 



RENT 



16 Units 



RENT 



A Acre 



B Acre 



C Acre 



Fig. 19 



Isl 2nd 3rd 
Units of Prod.factors 

A Acre 



illustrated by assuming that in a given community there are 
three grades of land which when cultivated with a given quan- 
tity of the other factors yield 24, 20 and 16 units of product, 
respectively. In the diagram, Fig. 19, the lines A, B and C rep- 
resent acres of the three grades and the rectangles the returns 
they make to the same investment. 

In pioneer days there would be land for everybody and to 
spare, so that even the best land could be had free. Those 
arcadian times soon pass, and the most desirable ground be- 
comes occupied and newcomers are forced upon inferior land. 
Those who own and cultivate their own land on grade A now 



RENT 313 

obtain four units per acre more than tliose producing on B land 
for the same investment. Those who cultivate A lands as 
tenants will be willing to pay up to four units of product as 
rent. They have the alternative of going onto free land at B, 
which produces but 20 units. By staying where they are and 
paying four units as rent they get a return of 20 units for their 
investment. The owners of grade A will not be able to raise 
the rent above four units or tenants will move to free land. 
If they charge any less than four, their tenants would be re- 
ceiving a return over and above what could be obtained on free 
land, competition for the use of A land would then raise the 
rent. There will be a tendency for the rent to be fixed at four 
units of product, which is the difference between what the given 
factors of production could earn at the margin of production on 
■ free land and what they could produce on superior land A. 

As there is more land of grade B than is required, no rent 
would be paid, but with the growth of the community, land at 
B would finally be occupied and land at C would come into use. 
Owners of A lands would now be able to exact eight units from 
their tenants and owners of B four units, which in each case 
is the excess product which the same factors of production 
could obtain by use of the superior land over what they could 
earn at the margin on C land. In the course of time, as the 
community develops and more and more land is brought into 
use, the tendency will be for the margin of production to be 
lowered and rents to be raised. Under actual conditions, the 
process, of course, will not be so evenly graded; part of the new 
lands made available may be more productive than some in 
use formerly, as was the case last century in the states when 
transportation transferred the margin of cultivation from the 
rocky New England states to the broad, rich lands of the middle 
west. The development of agricultural science and machinery 
may also tend to counteract the fall in the margin. The preced- 
ing account, however, illustrates the trend of events in relation 
to land over long periods of time. 

In the above illustration we have assumed that as the com- 
munity developed the expanding population would be employed 
and fed by opening up new land and that each grade of land 
would be cultivated with equal intensiveness. This, of course, 



314 PRACTICAL ECONOMICS 

would not be the case. As the industries of the country grew, 
the increasing supplies of labor and capital would be applied 
more intensively to the better grades, and the extra product 
would be obtained by intensive as well as extensive cultivation. 
These two processes would proceed side by side and would both 
result in a higher cost per unit of product or a lower return to 
equal units of labor and capital. 

Suppose that by applying a second unit of productive fac- 
tors on A land, that is, by doubling the investment, the total 
production is increased by 20 units. It would then be imma- 
terial, so far as the return in product is concerned, whether 
the extra productive factors were employed intensively on A 
or extensively on B. If we assume that a third unit applied 
to A would still further increase the product by 16 units, it is 
evident that it would not pay to cultivate A so intensively as 
this while free land at B yields a return of 20 units. At a later 
period, however, when the community is forced to have recourse 
to inferior land at C, which only yields 16 units, it will pay to 
cultivate A more intensively by applying a third unit. Figure 19 
represents A so cultivated. The return to the marginal dose of 
labor and capital on A is 16 units, the same yielded at the 
extensive margin on C land. Intensive and extensive cultiva- 
tion will thus proceed simultaneously, and the tendency will 
be for each grade of land to be cultivated to that point where 
the returns to the marginal dose of the productive factors em- 
ployed on it correspond with that which the same factor would 
produce on marginal land. 

The rent for an acre of A land will tend to correspond to 
the surplus product the productive factors employed on it pro- 
duce over and above the return they obtain at the margin on C 
land. The producers have the alternative of going onto free 
land at C or cultivating B land more intensively; in either case 
they would net 16 units of product each, or 48 in all. The 
owner of A land will be able to secure the surplus due to the 
superiority of his land, as rent. In Fig. 19 the area above the 
dotted line measures the rent of an acre of A land under in- 
tensive cultivation. In both cases the rent is the surplus 
product over and above that which the productive factors earn 



RENT 315 

at the margin of cultivation, and as it is at the margin that 
the normal returns to the factors are set, rent appears as the 
surplus product over and above the normal rates of the other 
factors. 

We have assumed that the normal returns to the other factors 
of production are determined at the extensive margin of cul- 
tivation by the return they obtain on free land. We could as 
easily have measured them from the intensive margin by the 
return to the last or least productive unit employed. In the old 
countries there is little, if any, free land, and for many purposes 
in the states the land at the margin, the poorest land in use 
for the particular purpose, is not free land, but commands a rent. 
Rent would arise, however, and would still be a surplus over 
and above the normal returns to the factors employed if there 
were only one kind of land, providing that were scarce. As the 
demand for the product of the land grew, it would be obtained 
by more intensive cultivation. More and more labor and capital 
would be massed on the land. The price of the product would 
be determined by the cost of the most expensive portion, that 
raised in this case at the intensive margin. This price must 
remunerate the labor and capital employed at the margin and 
represents the normal rate of return to these factors. Those 
units employed above the margin produce a bigger product, 
which, as it is sold at the same price, affords a surplus over its 
cost. This surplus over and above the normal rates to the 
factors employed on the land would go to the owners as rent. 
As more and more product was required, it would be obtained 
by a more intensive cultivation of the land. The margin of 
cultivation would be lowered and rents raised. The price of the 
extra product would be raised or the standard of living of the 
workers lowered. 

THE TENDENCY FOR THE VALUE OF LAND TO RISE IN 
THE LONG RUN 

The fact that land is distinguished from its partners in pro- 
duction, in that it does not possess a supply price based on cost, 
gives those partners a preferred claim on the joint product. The 
equilibrium prices of the other factors can never sink perma- 



316 PRACTICAL ECONOMICS 

nently below their casts, which acts as minimum; while that of 
land may fall to zero. But this is only looking at one side of a 
fact. A supply price based on cost is like a double-edged sv/ord 
in the hands of the law of value; it cuts in two directions. It 
may sever the price of land altogether, should the joint product 
be insufficient to satisfy the minimum claims of the other fac- 
tors, but it just as surely shears their prices off when they rise 
above their respective costs. Just as in the case of a commodity, 
a price much above cost acts as a stimulus on the supply, the 
increased supply lowers the price; so that in the long run the 
equilibrium price tends to correspond with its cost of produc- 
tion. The same tendency is true for wages, interest and profits. 
Thus, if the earnings of any class of labor rise above normal, a 
compensatory action increases the supply of that kind of labor, 
and wages will fall, just as profits above the ordinary in any 
particular line of business after a while disappear for the same 
reason. The dynamic connection between the earnings of labor, 
capital and organization and their supplies acts as an automatic 
check on their rise. But for rent there is no such check; high 
rents do not increase the supply of land and establish a new 
and lower equilibrium price. There is no limit to the share of 
the joint product that may go to land except the minimum that 
must be paid to the other factors. And the conditions are such 
that in the long run the tendency is for land to exact a larger 
relative share; to press down on the minima of the other fac- 
tors and exact an ever-growing surplus for its owners. 

The situation may be summed up as follows: The price of each 
of the four factors of production is determined by the relation 
between the supply of it and the demand for it. The supply of 
land is limited, that of each of the others tends to increase. The 
increase in the supplies of the others means an increase in the 
demand for land. In the course of time land thus becomes rela- 
tively scarce and its value inevitably tends to rise. This, like 
all general statements, needs to be qualified. The available 
supply of land may be subject to increase. Over short periods 
the supplies of the other factors may also be incapable of in- 
crease. Competition is not perfectly free. Science and inven- 
tion may delay this tendency, but in due course of time, as the 



RENT 317 

history of the older nations show, it inevitably asserts itself. 
The margin of production tends to fall, and the returns to the 
other factors to be lowered, while the surplus going to the owners 
of land tends to increase; a larger proportionate share of the 
national income thus flows into the pockets of the landlords; land 
values rise. 

THE ETHICS OF RENT 

This brings us to the ethical aspect of the rent question. The 
owners of land have been accused of reaping where they have 
not sown, and rent has been described as a parasite form of 
income, in that it is due to the labor of others and not to any 
productive effort on the part of those who receive it. In the 
strictest theoretical sense this may be true. Economic rent is 
the return paid for the land; the income from improvements to 
the land by the owner are classed as interest. All wealth is the 
result of the application of man's productive efforts to land. 
To labor, to create and save capital, to organize enterprises, 
involves effort and sacrifice. Wages, interest and profits are 
payments made in return for productive effort or sacrifice on the 
part of those who receive them. The landlord receives a return 
for the productivity of his land, not for any productive effort on 
his own part, except it be that of collecting the rent. It is 
true that rent, from the viewpoint of society, is a surplus over 
and above the cost of production paid to the owners of land. 
But so long as a country allows private ownership of land, those 
who own the land have a right to exact a rent for their land 
from those who wish to use it also for the purposes of private 
profit. It is also true that the majority of those who own land 
have paid for it with money they have earned by their own 
productive effort. And that each of the other individual pro- 
ducers has been paid for the part he has played. If land were 
nationalized, rent would still exist, only it would be paid to the 
nation. It has been suggested that private property in land 
should be abolished. But while it might be a wise and just plan 
for a new community to retain possession of the land, rent it 
and use that rent for the common good, it would plainly be 
unjust as well as unwise to confiscate the real estate of an old 



318 PRACTICAL ECONOMICS 

country or the income from it, which, in most cases, represents 
a return on an investment made by the owner, similar to an 
investment of capital. 

The most practical question relating to land has to do with 
the increase in land values due to the tendency for rents to 
increase as a country develops. This increased valuation was 
termed the "unearned increment" by John Stuart Mill and has 
ever since gone by that descriptive title. The value of a piece 
of real estate depends on the income it will bring to its owner, 
and its selling value is found by capitalizing the rent that may 
be obtained for it at the current rate of interest. . The value of 
real estate increases with the rise in rents. Rents rise as the 
productivity of the land increases. The increase in land values 
that inevitably occurs as a country develops is due not to the 
owners of the land, but to the general progress of society. City 
lots, especially, owe their high rents and values to social causes, 
to the growth of cities, the development of trade and transpor- 
tation and the activities of the community as a whole. Manhat- 
tan Island was purchased from the Indians by Peter Minuit for 
the Dutch in 1626 for 60 guilders, about $24, or $100 in modern 
value worth of pots, pans, axe-heads, blankets and beads. Lots 
purchased by John Jacob Astor a hundred years ago on the 
same island for a few thousand dollars are today worth millions. 
>As an alternative to the nationalization of the land, it has been 
proposed that the increase in land values not due to the exer- 
tions of the proprietors but to the progress of society should be 
secured by taxation. One of the many difficulties in the execu- 
tion of this plan is that the values of land and improvements are 
so intertwined that it is exceedingly hard to distinguish between 
them. The question of taxation requires separate treatment be- 
yond the scope of present space; enough has been said to show 
the close practical relation that exists between the nature of 
rent and taxation. 

TEST QUESTIONS 

1. Explain the difference between "economic" and "commercial" reat. 

2. In what sense is rent a surplus form of income? 



RENT 319 

3. What are the two chief causes of the productivity of agricultural 
land? 

4. What factors govern the location of factory sites? 

5. How does location influence the value of store sites? 

6. How does the supply of land differ from that of the other factors of 
production? 

7. Why as a country grows will land values tend to increase? 

8. Is it right to say that ordinary "commercial rent" is unearned? 

REFERENCES 

BuTTERWORTH, H. L., The Farmer and the New Day. 

Carver, T. N., Principles of Economics (Chap. XXXIV). 

Clay, H., Economics for the General Reader (Chaps. XIX-XX). 

Ely, R. T., Outlines of Economics (Chap. XX). 

George, H., Progress and Poverty. 

GiDE, C, Pohtical Economy (Book IV, Part II, Chap. III). 

HuRD, R. M., The Principles of City Land Values. 

Jevons, W. S., Theory of Pohtical Economy (Chap. VI). 

Johnson, A. S., Rent in Modern Economic Theory. 

Marshall, A., Principles of Economics (Book VI, Chaps. IX-X), 

Nicholson, J. S., Pohtical Economj^ (Book II, Chap. XIV). 

Pantaleoni, M., Pure Economics (Part III, Chap IV). 

PiERSON, M. G., Principles of Economics (Vol. II, Chap. V). 

RiCARDO, D., Political Economy. 

Seager, H., R., Principles of Economies (Chap. XIV). 

Seligman, E. R. a., Principles of Economics (Chap. XXIV). 

Smith, A., Wealth of Nations (Book I, Chap. XI). 

Taussig, F. W., Principles of Economics (Chaps. XLII-XLIV). 

Walker, F. A., Land and Its Rent. 



CHAPTER XXVI 

WAGES— FACTORS ON THE DEMAND SIDE 
PECULIAR IMPORTANCE 

The share of the joint product of industry assigned to men 
for their labor is known as wages. The term, labor, includes all 
mental and manual power expended in the satisfaction of eco- 
nomic wants, from ditch-digging to managing a billion-dollar 
corporation. All remunerations for personal services such as 
salaries or fees are included under the head of wages. When 
men are in business for themselves, the share of the joint product 
assignable to their own labor strictly speaking, may be more or 
less merged with the othier shares, rent, interest or profit. Many 
farmers and small tradesmen do not clearly differentiate be- 
tween profits, interest and wages. 

Yet in a vital sense, wages differ from rent, interest and 
profits, in that the latter are derived from productive property, 
but the source of the former is man himself. Wages are 
paid for the personal services of human beings, whereas rent 
and interest are paid for the use of land and capital. It is true 
that what is paid for in each case is productive power but the 
crucial fact is that in the case of land, capital and organization, 
the owners and the productive powers of their respective factors 
are separable but the laborers and his labor are in position of 
the Siamese twins. There can be no absenteeism with labor. 
It makes little difference to the capitalist where his capital is 
used, whether in a sewer or in an office, but to the laborer it 
may be a matter of considerable concern. In effect, therefore, 
while rent is paid for the use of land and interest for the use of 
capital, wages are paid for the use of men. 

Then again wages derive a peculiar importance from the nat- 
ural law summed up in "the edict of Eden" that man shall live 

320 



WAGES— FACTORS ON THE DEMAND SIDE 321 

by the sweat of his brow. For unless relieved by an inheritance, 
he depends for his livelihood on the returns he secures from his 
labor. He may, it is true, as a result of previous labor of his 
own and others, amass sufficient wealth to maintain him in idle- 
ness during the remainder of his life, but in the world as it is, 
the great majority of mankind are dependent on their wages 
for a living. This is accentuated by the fact that labor cannot 
like capital be stored, but is highly perishable. 

The subject of wages, therefore, is an intensely personal one; 
in any theory of distribution it occupies a place of para- 
mount importance. Labor is the primary source of all 
wealth and it is in the form of wages that two-thirds of those 
engaged in gainful occupations receive their share of the things 
that make life worth while. It is no exaggeration to say that 
of all matters under the sun there is no one that concerns us 
quite so closely from the office boy to the general manager, as 
the contents of our pay envelopes. But, before we see what de- 
termines the size of their contents, we should notice some practical 
facts about wages and their methods of payment that will give 
us a broader view of the wage question. 

METHODS OF WAGE PAYMENT— TIMEWORK 

The two primary forms of wage payments are timework and 
piecework. The former is the older and up to quite recently was 
the commoner. In the days of craftmanship and in the early 
part of the factory system when labor was not highly special- 
ized, and the close relation between employer and employee 
rendered supervision easy, the timework method of payment was 
satisfactory. And for many kinds of work it is still preferred. 
In the higher positions, in small plants, or where the work is of 
a varied character as farm laboring, salaries and day pay are 
not only preferable but often the only feasible method of re- 
muneration. The chief advantage to the worker lies in its stabil- 
ity, for especially as the length of the time unit increases he is 
assured of a steadier income. 

But with the change from small to large scale production, the 
time method of payment has shown its unfitness for many kinds 
of work, both from the viewpoint of the employer and the em- 



322 PRACTICAL ECONOMICS 

ployed. When large numbers of men are engaged in one plant 
on the same kind of work, there is a tendency to a deadening uni- 
formity — both of effort and of reward. It becomes as difficult 
for the superior workers to obtain recognition as for the em- 
ployer to recognize superior ability. The pay comes to be based 
on the average worker and the output adjusted to average pay. 
This kills initiative; the superior worker slackens his pace to 
that of the less efficient; the productivity of labor is lessened; 
cost is high and wages low. 

PIECEWORK 

To increase output and stimulate individual effort the piece- 
work system came into prominent use. The employee is paid 
not by the hour, week or month, but so much per piece for 
work turned out. A high degree of specialization and a stand- 
ardized product consisting of large numbers of similar units, 
made this plan feasible. The rate of pay is based on the old 
day time earnings. If an average worker turned out ten units 
of product a day and received $2.50, the rate would be set at 
25 cents per piece. Should he produce only eight units, he re- 
ceives only $2.00 for the day, but should he finish twelve, his 
daily earnings rise to $3.00. The employer is relieved of the 
necessity of driving, for this system stimulates all workers and, 
moreover, rewards them in relation to their varying abilities. By 
a system of inspection, the quality of the product may be assured 
though for particular work requiring a high degree of accuracy 
the piece rate plan may not be desirable. Not only does the 
faster worker receive higher earnings but the employer makes 
bigger profits; for the larger the number of pieces turned out, 
the smaller is the amount of overhead to be charged to each, 
and therefore, the lower the cost of each. 

Notwithstanding the advantages of this plan, in practice it 
has failed through interference on the side of the employer 
and partly through opposition from the side of labor. One cause 
of its failure was due to the cutting of the rates by employers. 
This little historical comedy affords an interesting if not flatter- 
ing glimpse into human nature. Now that it was to the em- 
ployee's adva,ntage to work, he did so with a vengeance, doub- 



WAGES— FACTORS ON THE DEMAND SIDE 323 

ling and trebling his output in many cases and likewise his pay. 
Though no doubt this increased output was abnormal in some 
cases, being due to over-stimulation or intense competition, in 
many cases it disclosed the wholesale prevalence of "soldiering." 
At any rate employers even though they gained by the increased 
output, could not bear to see their employees earning such un- 
usually large sums and so cut the rates. The disgruntled em- 
ployees forced to work harder and harder to earn a small in- 
crease in pay, became wary of increasing their output and nat- 
urally suspicious of piece-rate methods. 

For other reasons piecework has been opposed by the workers 
either individually or by concerted action through their unions. 
It is a more precarious method of payment; while the worker 
may earn more he may through the inefficiency of his employer 
earn less. The responsibility of the employer to furnish the em- 
ployee with steady work is somewhat lessened. It is claimed 
that it leads to intense competition among the workers, result- 
ing in over-stimulation, injurious to health. 

THE NEW COMBINATIONS 

With a view of combining the advantages of time and piece- 
work and eliminating as far as possible their disadvantages, 
there have arisen a number of wage systems commonly called 
premium and bonus systems. These recognize the right of the 
employee to a minimum wage and have as their basis a straight 
hourly rate. A definite time allowance is set for each job, 
and an additional compensation is paid for work completed with- 
in, or in less time, than the standard. The first of these new sys- 
tems to be introduced into the United States was the Halsey 
premium plan. A standard time is set for each job. Usually 
under this system the standard time is based on past records 
of performance. The workman is paid at his usual rate. But 
if he completes the job in less than the standard time he receives 
a proportion, usually one-half or one-third of the time he saves. 
Thus, if his hourly rate is 50 cents and the job is scheduled to 
take three hours, should he complete it in two, he receives $1.00 
for the two hours plus twenty-five cents for half the hour saved, 
in which case he is paid at the rate of 621/2 cents an hour. Should 



324 PRACTICAL ECONOMICS 

the job take him more than three hours, he still receives the 
base rate of fifty cents. The workman is thus assured of a 
full day's pay but at the same time is encouraged by a reward 
to increase his output, while the employer though he may pay 
the employee a larger total wage, pays a lower rate per piece, so 
that high wages and low costs go together. The objection is 
sometimes made that under this plan the workman is paid at a 
lower rate for the extra work he performs; that part of the re- 
sults of his increased exertion go into the employer's pocket. 
This is true but is partly offset by the fact that in many plants 
where this plan is in operation the flow of work is greatly facili- 
tated by more efficient cooperation than usual on the part of 
the matiagement. 

The later systems, the most prominent of which are the Taylor 
differential piece rate plan, the Gantt task and bonus and 
the Emerson efficiency system, emphasize intimate cooperation 
between the management and the men; and are characterized 
by the scientific accuracy with which their standard tasks are 
determined. The idea of scientifically determining the standard 
time was originated by Frederick Winslow Taylor and forms 
part of the theory of scientific management presented by him 
before the Society of Mechanical Engineers in 1903. Taylor 
rightly avers that the failure of the piece-rate plan was due to 
''the ignorance of employers as to the proper time in which work 
of various kinds should be done." Under Taylor's system, the 
best method of performing the work and a fair time for its com- 
pletion are found by accurate motion and time studies. The men 
are carefully selected with a view to their fitness, are trained 
and the performance of the work is facilitated in every possible 
way by the cooperation of the management. The criticism is 
often made that the standard times of the new systems are so 
arduous as to be injurious to the health of the worker. When 
this is the case it is to be deplored for it is against the best in- 
terests not only of the workman but of the employer. But 
Taylor himself was very emphatic on this point and the school 
of industrial engineers who have followed him are, generally 
speaking, conservative in the setting of the standard times. 
Taylor's own words on this question are worth quoting: 



WAGES— FACTORS ON THE DEMAND SIDE 325 

These tasks are carefully planned so that both good and careful 
work are called for in their performance, but it should be distinctly 
understood that in no case is a workman called upon to work at a pace 
which would be injurious to his health. The task is always so regulated 
that the man who is well suited to his job will thrive while working 
at this rate during a long term of years and grow happy and more 
prosperous instead of being overworked. 

The most remarkable thing about the new wage systems is 
that they have succeeded in uniting, what before seemed to 
most employers and employees, to be most unnatural bed- fel- 
lows, namely, high wages and low costs. They have demon- 
strated Taylor's claim, "that it is possible to give the workman 
what he most wants — high wages — and the employer what he 
wants — a low labor cost — for his manufactures." Cheap labor 
is not always so cheap nor is the causal relation between high 
wages and high costs and prices as simple and inevitable, as is 
sometimes claimed. 

SOME CONSIDERATIONS AFFECTING WAGES 

In any estimation of wages one point to bear in mind is the 
distinction between nominal and actual earnings. The old 
proverb that "things are not always what they seem" is true 
of wages as of other things. Big daily wages may not be so 
big if irregularity of employment is taken into account, as in the 
case of bricklaying and in some mining operations. A smaller 
daily rate with regularity of employment may in the long run 
mean larger total earnings. A high wage in a dangerous occu- 
pation or one pursued at high tension may on account of the 
shortened working life of the operative, mean lower total earn- 
ings. A lower piece or bonus rate in a concern that equips its 
employees with the most up-to-date machinery and backs them 
up with efficient cooperation may result in larger earnings than 
a higher rate in an inefficiently managed plant. The same prin- 
ciple applies to a sales force on a commission basis; it is not 
only the commission that affects total earnings but also the co- 
operation the salesman gets from the house. 

Quite as important when estimating earnings at different 
periods or places is the distinction between money wages and 



326 PRACTICAL ECONOMICS 

real wages. Not the number of dollars in the pay envelope but 
the quantity of goods those dollars will purchase constitutes real 
wages. Owing to the fact that changes in wages fail to keep 
pace with changes in the prices of commodities in general, at 
two different periods though money wages remain the same, real 
wages may radically differ. The idea of what constitutes a 
fair wage is fixed by the traditional money wage of an occupa- 
tion and in periods of rising prices considerable injustice is apt 
to be done because of failure to take into account the shrinkage 
in real wages which occurs. Not only the interest of the employer 
but the evidence of the senses on both sides act as deterrents. 
The same amount of dollars is paid and received; and if per- 
chance the number of dollars is increased, it seems to both like 
a real increase, whereas the addition may still leave the 
employee's real wages smaller than before. Some concerns dur- 
ing the war adopted the wage index method of payment, raising 
the money contents of the pay envelopes in accordance as a 
price index indicated rises in the general level of prices. How 
this will work now that prices are falling, remains to be seen. 
While such a plan would be difficult of general application and 
hardly necessary under ordinary conditions in an abnormal 
period such as we have just passed through, it has much to com- 
mend it. As stated in our discussion of the effects of price 
changes, real wages tend to vary inversely with changes in the 
general level of prices, decreasing in a period of rising and in- 
creasing during a period of falling prices. It should be noticed, 
however, that in periods of rising prices, employment is more 
constant, a fact which especially in the lower ranks of labor 
by increasing total earnings, somewhat mitigates the shrinkage 
of real wages. The reverse is true in periods of falling prices, 
when the dread spectre of unemployment stalks among the 
workers, reducing their total earnings and in many cases bring- 
ing no wages at all. 

According to an investigation conducted by the United States 
Bureau of Labor Statistics, based on the retail prices of a set of 
commodities chosen to represent the expenditure of an average 
family, the cost of living in the United States has increased from 
1913 to 1920, 16.5 per cent. Wholesale prices reached their high 



WAGES— FACTORS ON THE DEMAND SIDE 327 

water mark in May, 1920, when measured by the Bureau of 
Labor Statistics' weighted index they registered 272; in June, 
they dropped to 269, in July to 262 and in August to 250. The 
Bureau's weighted index number of the retail prices of twenty- 
two principal food articles with 1913 as the base year, reached 
its maximum in July, registering 219; in August it fell to 207; 
September 203; October 198. In the usual course of affairs 
wholesale prices move first, then retail prices; while the cost of 
living brings up the rear held back somewhat by high rents. 

Real wages are also affected by considerations outside the pay 
envelope. Unhealthy conditions in the plant and harsh man- 
agerial policies discount even big pay. On the other hand, pleas- 
ant working conditions, opportunity for advancement and educa- 
tion augment real wages. Local environment, social considera- 
tions, vacation periods, enjoyment of the work and a deep satis- 
faction in its results, all enter into the pay a man receives for 
his daily tasks. 

GENERAL STATEMENT OF THE PROBLEM 

Under our present economic system the price of human serv- 
ices like the price of commodities is determined by the law of 
demand and supply. When labor is urgently desired and is 
plentiful, wages will be low. Such a statement of the cause of 
high or low wages is so general as to be of little practical value. 
In order to understand why wages in a given trade or profession 
are high or low, or to be able to estimate the trend of wages 
for a given line of work ten years hence, our knowledge must 
be more definite. We need to know not only the general cause 
but the underlying particular causes which together govern the 
action of the general law. What are the factors governing the 
supply? What determines the scarcity of labor and on the other 
hand, what factors govern the demand by affecting the desire 
for labor or its productivity? 

One of the first things to bear in mind is that the wage of 
an individual or class of individuals, is the resultant of a number 
of distinct though interrelated causes. Sometimes one and some- 
times another may be the more active or conspicuous, but the 
wage is influenced by the action of all. A theory is simply 



328 PRACTICAL ECONOMICS 

an explanation of fact, and some theories have attempted to 
explain wages by attributing their determination to some one 
factor. The old subsistence theory of the Physiocrats which gave 
rise to the so-called "iron law of wages," looked at wages from 
the supply side and saw them determined by the subsistence 
of the laborer. The value of labor like that of commodities, 
they thought, was determined by cost of production. The pro- 
ductivity theory as it is often explained, errs by over-emphasiz- 
ing the factors on the demand side. In order to obtain a well 
rounded, unbiased view we should first note the general truth 
that wages are the resultant of several separate though inter- 
acting factors. The next thing is to get a clear view of each 
of these, their mode of action and as far as possible their re- 
lation to each other. The value of labor, like all values, is in- 
fluenced not only by material things capable of measurement 
but by mental forces hard to estimate. To analyze all of the 
factors immediate and remote which influence the wages of dif- 
ferent kinds of labor would be a task indeed, but it is possible to 
single out the most important. A knowledge of these places a 
fairly practical answer in our hands to the question: How are 
wages determined? We shall flrst turn our attention to the fac- 
tors influencing wages on the side of demand. 

WAGES AFFECTED BY DEMAND FOR LABOR'S PRODUCTS 

The demand for labor is derived from that of the products 
produced by its aid. Any increase in the demand for the prod- 
uct of a particular industry will increase the demand for workers 
in that industry, and tend to depress wages. Any increase in 
the price of a joint product acts to raise the productivity of 
its factors of production. In the chapter on distribution, it 
will be recalled, the productivity of nitrogen was increased by 
the rise in the price of wheat. In a study of the figures published 
in the Monthly Review of the Bureau of Labor Statistics on 
wage movements during the war, the greatest advances are 
shown to have taken place in those industries for the products 
of which the war created a special demand, such as the iron 
and steel industry, coal and mining and shipbuilding. Between 
January, 1915, and December, 1917, in the iron and steel industry. 



WAGES— FACTORS ON THE DEMAND SIDE 329 

employment increased 82 per cent, payroll 235 per cent, and per 
capita earnings 84 per cent! In other industries such as print- 
ing and glass blowing, the products of which were not so 
urgently demanded, the increase in wages was not so ex- 
treme. From 1912 to 1917 the wages of compositors and 
linotype operators (newspapers) advanced 111 per cent, while 
those of open hearth workers rose 187 per cent. The fact that 
the value of labor depends on the demand side on the demand 
for its products is of fundamental importance and has many 
practical applications. In choosing a trade or profession a young 
man should consider not only the present demand for the serv- 
ices he contemplates fitting himself to perform, but what that 
demand will be ten or twenty years hence. 

THE INFLUENCE OF EFFICIENCY ON WAGES 

Efficiency is one of the primary causes of productivity and 
hence exerts considerable influence on wages. In looking at 
the nation as a whole, the more robust in health is its working 
population, the more alert intellectually, the more highly edu- 
cated and trained, the more energetic in spirit, the higher will be 
the level of prosperity enjoyed by all classes including labor. 
And this not only because of the relation between the produc- 
tivity of labor and wages; but also by virtue of the fact that a 
vigorous and enlightened working force is better fitted not merely 
to produce wealth but to command a fair share of it after it is 
produced. 

The educational policies of the big corporations, the work of 
Taylor and the modern school of industrial engineers, bear unde- 
niable testimony to the fact that it pays to educate; while the 
new wage systems have demonstrated the connection between 
individual efficiency and wages. We are just at present inter- 
ested in the relation between efficiency and wages on the demand 
side. In any line of business good workers are preferred to 
poor ones, clever ones to clumsy, well trained to untrained, ex- 
perienced to inexperienced, willing to unwilling. The more pro- 
ficient a man is at his trade or profession, the more he will be 
in demand. A first-class salesman, not necessarily a brilliant 
man, but a steady producer, is in greater demand than a second 



330 PRACTICAL ECONOMICS 

rater. If paid on a commission basis, the relation between his 
productivity and earnings will be self-evident. But if paid a 
straight salary his pay will still be based on sales. About six 
years ago a superintendent of the Carnegie Steel Company re- 
signed to take a position as general manager of a big steel plant 
in Pennsylvania at a salary of $50,000 a year. In the first three 
months by one invention he reduced the costs of every ton of 
steel produced by fifty cents and as their annual output ran over 
a hundred thousand tons, he more than earned his salary by 
this one improvement. Big concerns are able to pay large sal- 
aries to men gifted with executive ability and constructive ideas 
because of the productivity of their services. 

Therfe is a disposition on the part of some to attribute the 
good fortune of others to luck or pull. There is no doubt but 
that these two take a hand in the game of life. But to those who 
are dissatisfied with their earnings it might be good advice to 
look to their personal efficiency; for often as Shakespeare puts it: 

"The fault, dear Brutus, is not in our stars. 
But in ourselves, that we are underlings." 

EFFECT ON WAGES OF EFFICIENCY OF OTHER 
PRODUCTIVE FACTORS 

The productivity of the worker is influenced not only by his 
own eflSciency but also by that of the other factors cooperating 
with him in the productive process. 

The addition to the total product that is attributed to any 
one of a group of productive factors and is said to determine 
the productivity of that one, in the sense that it is the amount 
that depends on its presence or absence, is, it will be recalled, 
not produced by that factor alone but is the joint product of 
all and is, therefore, influenced by the efficiency of all the con- 
tributing factors. The general result is that whenever several 
factors are engaged in the making of a common product an 
increase in the efficiency of any one increases the productivity 
of each of its fellows. The productivity of labor is enhanced by 
improved machinery or superior organization. 

N. I. Stone, who was connected with the United States Tariff 
Board, states that in the Board's investigation in the wool in- 



WAGES— FACTORS ON THE DEMAND SIDE 331 

dustry they found that almost invariably the mills paying 
higher rates of wages per hour produced goods at lower costs 
than their competitors paying lower wages. This, the Board 
found, was due partly to the more efficient management of the 
higher wage mills but more generally to the better machinery 
used in the higher wage and low cost mills. In the carding de- 
partment of seventeen worsted mills, the mill paying its machine 
operatives thirteen and eight-tenths cents per hour had a ma- 
chine cost of four cents per one hundred pounds, while the plant 
paying 11.86 cents per hour had a cost of twenty-five cents per 
one hundred pounds. This was due largely to the fact that the 
lower cost high wage mill had machinery enabling every operator 
to turn out more than 326 pounds per hour, while the high cost 
low wage mill was turning out less than forty-eight pounds per 
. hour. An investigation some years ago into shops operating un- 
der the Taylor System of scientific management, revealed the 
fact that where the system was in successful operation costs had 
been reduced and wages increased from 30 to 100 per cent. 

EFFECT OF IMPROVED MACHINERY AND 
ORGANIZATION ON DEMAND FOR LABOR 

The factors of production not only cooperate in the productive 
process but they compete for employment. Business men are 
ever seeking the most efficient combination and in so doing are 
always ready to substitute for any one factor another which 
may do more work for the same cost or the same work for less 
cost. If the job can be done cheaper by machinery, then ma- 
chinery takes the place of labor. While machinery can never 
displace labor in general, it may diminish or destroy entirely 
the demand for a particular kind of labor, just as the old 
wood cut engravers were thrown out of work by the invention 
of the half tone process, glass blowers by glass blowing ma- 
chines. From this fact arises the ancient antipathy of organized 
and unorganized labor to labor-saving machinery. One can 
scarcely blame workmen for opposing a device which if it does 
not actually take the bread out of their mouths at least scrapes 
all the butter off. To tell them that it is for the ultimate benefit 
of labor in general is poor consolation. Whether it be salesmen 



332 PRACTICAL ECONOMICS 

discharged because of a centralization of sales through a com- 
bination of hitherto competing concerns, or mechanics thrown 
out of employment by inventions, the immediate effect is dis- 
tressing and those who bear it are martyrs to progress. It is 
unfair that a few should bear the brunt of a process which en- 
riches society as a whole. In some cases by arrangements be- 
tween the unions and the bosses as when the linotype machines 
were introduced in the printing trade and the molding machines 
in the stove industry, provision is made for the men to work the 
new machines. It was always Taylor's policy in installing his 
system of scientific management in a plant, not to discharge 
employees who might be displaced by the changes made, but to 
find them positions elsewhere wherever possible ; that is also the 
policy today of the leading industrial engineers and of many big 
concerns. Such a practice is not only eminently fair but ex- 
pedient in that it tends to lessen the animosity of manual work- 
ers to improved machinery and inventions. 

On the other hand though invention whether along the line of 
improved machinery or methods of organization does often 
diminish and even annihilate the demand for a particular kind 
of labor, its general effect on labor in the long run is to increase 
demand. Machinery practically destroyed the old time shoe- 
maker's occupation and inventions like the McKay sewing ma- 
chine threw out of work numbers of specialized workers. But as 
a result of the introduction of machinery into the shoe industry, 
costs and prices have been so lowered that whereas one hundred 
years ago only the wealthy few could afford to own a pair of 
shoes, today they are within reach of ail. And with the in- 
creased demand for shoes the demand for makers of shoes has 
so grown that there are more people relative to the population 
engaged in the shoe industry today than when shoes were made 
laboriously by hand. Moreover, another army of auxiliary 
workers finds employment in the manufacture of shoe ma- 
chinery and accessories and the raw materials required for 
these. It is evident then that if machinery throws some out of 
work it finds new work for others, and wherever the demand for 
the product is elastic the increase of that demand through the 
lowering of price acts likewise to increase the demand for labor. 



WAGES— FACTORS ON THE DEMAND SIDE 333 

This is the lesson history teaches. If Stevenson's locomotive 
threw a few teamsters and canal men out of work, it has re- 
deemed itself since by finding employment for thousands of 
railroad engineers, conductors, firemen, locomotive builders, and 
so on ad infinitum. In the long run, machinery is a staunch 
ally of labor and tends to raise real wages not only by reducing 
the cost of commodities but by increasing the productivity of 
labor and thus its price, and by increasing the demand for the 
products of labor and thus that for labor itself. 

SUMMARY 

Wages are influenced on the side of demand by — 

1. The demand for labors' products 

2. The efficiency of the worker 

• 3. The efficiency of the other factors of production 

4. The supply of and the demand for the other factors that 
compete with it for employment. 

TEST QUESTIONS 

1. Why is the share of a nation's income paid as wages of especial 
importance? 

2. What are the two fundamental forms of wage payment? 

3. What have the new wage systems demonstrated? 

4. Why is it well to distinguish between real wages and money wages? 

5. What are the chief factors influencing wages on the demand side? 

6. Explain the effect of improved machinery and organization on wages. 



CHAPTER XXVII 

WAGES— FACTORS ON THE SUPPLY SIDE 
GROWTH OF POPULATION— INTERNAL 

Turning our attention to those factors influencing wages on 
the supply side, we come first to the general effect on the labor 
supply of an increase in population. While it is obvious that 
the total population and the labor force of a country are 
not one and the same thing, owing to the fact that the 
population includes many women and children, aged people 
and others, unwilling or unable to work who are not engaged 
in gainful occupations, it is nevertheless true that an increase in 
the population means an increase in the labor supply or to be 
exact on the supplies of different kinds of labor. In any given 
country the growth of population depends, first on internal 
growth, that is, the excess of births over deaths; second on im- 
migration and emigration. 

All discussions of population have been profoundly influenced 
by Malthus, who in his essay, on "The Principle of Population 
as it affects the Future Improvement of Society" first published 
in 1798, propounded a theory that set the world agog. Accord- 
ing to Malthus, the one great cause impeding the progress of 
mankind toward happiness is the "constant tendency in all 
animated life to increase beyond the nourishment prepared for 
it." This arises from the fact that all animated beings are im- 
pelled by a powerful instinct to reproduce. In irrational animals 
and plants, this instinct is not checked by doubts as to the 
future provision of the offspring so that whenever there is liberty 
the power of increase is exerted and the superabundant effects 
are suppressed by want of nourishment. In man it is checked 
by reason in the shape of considerations regarding the difficulty 
of providing for the offspring, the sacrifices that must be made 

334 



WAGES— FACTORS ON THE SUPPLY SIDE 335 

and so on. This "moral restraint" often leads to vice but "if re- 
straint is not exercised the human race will be constantly en- 
deavoring to increase beyond the means of subsistence because 
of the fact that naturally population would tend to increase by 
doubling itself every 25 years or in geometrical ratio as 1, 2, 4, 
8, 16, 32, while the food supply would only increase in arithme- 
tical ratio as 1, 2, 3, 4, 5, 6. In a nutshell the Malthusian prin- 
ciple of population asserts that population ever tends to press 
on the means of subsistence. In so doing, it is restrained by two 
classes of checks, the preventive, termed by Malthus moral re- 
straint, which restricts the birth rate and the positive checks, — 
misery and vice — which include all those causes which tend to 
shorten human life. 

Malthus proved his theory by an exhaustive historical ex- 
amination of the action of the checks in a large number of 
races from the time of the ancient Greeks and Romans to Great 
Britain in his own day. In principle undoubtedly Malthus was 
right, and as far as the past went he probably painted his picture 
of the operation of the checks none too blackly, nor indeed did 
he exaggerate their effects on the lower classes in the England 
of his time. But his picture of the future was somewhat darker 
than time has proved to be the case. The hand of progress in 
civilized countries has since somewhat accelerated the action of 
the preventive and lightened the operation of the positive checks. 

POSITIVE CHECKS 

The three principal checks to population acting on the death 
rate are famine, war and disease, — mankind's ancient enemies. 
During the nineteenth century industrial progress in the principal 
civilized countries has placed their population in normal times 
beyond the reach of famine. Yet it ever hovers on the outskirts 
and in times of depression or sickness is a very real menace to 
the poorer classes; while in the hygienically more backward 
countries it still descends at awful intervals, as at Shantung, 
China, and carries off its victims by the thousands. War, too, 
in spite of hopes and claims to the contrary continues to make 
its periodical onslaughts and its bloody jaws are scarcely dry 
from its latest killing. In the case of disease, medical and san- 



336 



PRACTICAL ECONOMICS 



itary science and hygienic education have done much to lessen 
its ravages, and account for the lowering of the death rate in the 
principal civilized nations during the last seventy years. 

WORLD'S DECLINING DEATH RATES 
1881-85 '8G-dO '91-'85 '90-'1900 '01-'06 '06-'10 1916 1917 





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One of the most gratifying features in this direction has been 
the marked decrease in the rate of infant mortality that has 
taken place in most civilized countries. In the United States, 
the death rate for men and women between forty and sixty years 
of age is higher than in most European countries chiefly on ac- 



WAGES— FACTORS ON THE SUPPLY SIDE 337 

count of the high death rate from organic diseases of the heart, 
nephritis and Bright's disease, which is attributed by some to the 
high nervous tension of business life in this country. A large 
number of deaths are due to preventable causes. The advance of 
medical science, better living conditions, more attention to per- 
sonal hygiene, especially in the case of city dwellers who are 
handicapped in obtaining the fresh air, exercise and sunlight 
essential to the best of health, will tend still further to lower 
the death rate and prolong human life. 

VOLUNTARY CONTROL— THE STANDARD OF LIVING 

Nature's crude method is to encourage the reproduction of the 
species by powerful instinct and cut down the surplus with her 
three death sickles, famine, war and disease. Man as a rational 
being seeks to prevent overcrowding and its disastrous conse- 
quences by bringing fewer into the world. He is influenced by 
considerations regarding the difficulty and expense of the future 
provision of his offspring. This set of considerations called by 
Malthus "moral restraint" is usually discussed in modern 
economic treatises under the head of the standard of living or 
the standard of life. In its strictest sense the standard of 
living consists of those desires, the satisfaction of which an 
individual or class of individuals consider as essential to their 
happiness and to gain which they will make any reasonable 
sacrifice such as the postponement of marriage. It is in essence 
a psychological thing, a concept more or less definite, represented 
in material life by those necessaries and comforts which a man 
has become accustomed to regard as his right and without which 
he would not consider life worth while. 

These considerations may lead him to remain single or post- 
pone marriage till late in life or to limit deliberately the size 
of his family. A moderate salary will enable a single man to 
enjoy life on a comparatively comfortable scale, while marriage 
means a division of his income by two and a renunciation of 
some of the luxuries of bachelorhood. He is reluctant to put his 
neck into the marriage yoke and shoulder its difficulties and re- 
sponsibilities. Moreover, owing to the increasing length of the 
required period of preparatory training for business and the pro- 



338 



PRACTICAL ECONOMICS 



fessions, many young men when they want and ought to marry 
cannot afford to, and are forced perchance to see the girl of their 
choice carried off by some old but wealthy rival. Nor is this 
matter by any means only a man's question. Many girls today 

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earn as much if not more than the men with whom they as- 
sociate. Such a one with a salary enabling her to live com- 
fortably and dress stylishly, must be genuinely in love to throw 
up her independence and marry a man with a salary no larger 
perhaps than her own, knowing full well it means going without 



WAGES— FACTORS ON THE SUPPLY SIDE 339 

many things so dear to the feminine heart. The "chum mar- 
riage" of our big cities may offer a loophole. Both husband and 
wife may work, living comfortably, even luxuriously, on the 
double income in a small flat. Here we come to the third and 
perhaps the most drastic aspect of this question. 

It is not only by preventing unions or deferring the marriage 
age but by limiting the number of the family after marriage that 
the standard of living gets in its work on the birth rate. A 
glance at the vital statistics of the principal civilized nations for 
the last century leaves little doubt but that the decrease in the 
birth rates which began in the latter half of the nineteenth cen- 
tury and is still continuing, has been brought about not by a de- 
crease in the number of marriages but by a deliberate restriction 
of the family. 

In France where the birth rate fell from 3.16 per cent per 100 
for the period 1806-1816 to 2.05 for 1901-1911, the marriage rate 
only dropped 1.63 to 1.52 per 100. Figures for England and 
Wales show a similar relationship; during the period 1876-85 the 
birth rate per 100 of population was 34.2; it dropped to 28.6 
for the period 1896-1905. The marriage rates for about the same 
periods changed only from 16.6 per 100 during 1861-70 to 15.6 
for 1891-1900. The birth rate for France had further declined in 
1913 to 1.88 per 100 while in the United Kingdom it had sunk 
to 15.0 per 1000. The vital statistics of the United States have 
been and still are shamefully inadequate. With the exception 
of one or two States in the East, Massachusetts for example, 
there has been an utter dearth of reliable statistics. The present 
birth registration area of the United States covers only 53 per 
cent of the total population. The death registration area covers 
but 81.1 per cent. Estimates based on what figures have been 
available indicate that the United States is following the Euro- 
pean fashion. Indeed, statistics are hardly necessary; the large 
families of colonial times are becoming as rare as the large flocks 
of wild pigeons that once roamed the continent. The birth rate 
for the United States registration area in 1915 was 24.3. 

A characteristic of the preventive check often remarked is the 
uneven manner of its action. Some concern has been expressed 
because of the fact that in most countries statistics show that the 



340 PRACTICAL ECONOMICS 

higher classes, so called, are only just holding their own, if not 
actually failing to maintain their numbers, while the laboring 
classes by virtue of their larger families tend to increase in spite 
of their higher death rate. Population is thus said to be growing 
at the bottom rather than at the top. It is a question, however, 
as to what part of the superiority of the higher classes is due to 
heredity and what to education and environment. If they con- 
stitute a superior strain of the human species it would be a 
pity to let them die off. If, however, the stock of the com- 
mon garden variety of mankind is capable of refinement and 
polish by education and environment, it might be as well to keep 
the walls of class division low enough to permit the free entrance 
of the rhore vigorous stock of the lower classes to replenish the 
withering of the upper. It is a rather peculiar biological paradox 
that the qualities that fit some for success in the immediate 
struggle for existence unfit them for perpetuating their kind. 
Probably this is exaggerating the actual facts; but there is no 
room for doubt that the preventive check is more active in the 
cases of the middle and upper classes than in the laboring classes 
which are not fired with the same intensity of ambition or gifted 
with the same degree of foresight or prudence in this particular. 

INCREASE OF POPULATIONS OF CHIEF COUNTRIES 

Notwithstanding the decrease in the birth rates, the popula- 
tions of the principal countries with the classic exception of 
France, continue to increase, as the accompanying chart shows. 

Statistics prove that high birth rates and high death rates 
usually go together owing to the more acute struggle for ex- 
istence, as is illustrated by the history of China and India. On 
the other hand, if the birth rate is so low as to approach the death 
rate, as in the case of France, the population will tend to be 
stationary and may even be threatened by race suicide. A 
gradual growth through a medium birth rate accompanied by a 
low death rate is the sanest, economic course for the older 
nations. 

THE MODERN TENDENCY 

The continuous decline in the birth rates of the leading coun- 
tries of the world which set in during the latter half of the nine- 



WAGES— FACTORS ON THE SUPPLY SIDE 



341 



teenth century and which is still in operation, seems to augur a 
new principle of population for twentieth century civilization, a 
principle born of the changed economic and social conditions of 



188G-'90 



WORLD'S DECLINING BIRTH RATES 
'91-'95 '96-1900 '01-'05 '09-'10'Il '12 '13 '14 



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modern nations. Before and during the time of Malthus, no 
doubt subsistence acted as a spring pressing down on population. 
On its release population increased ; when it pressed down popu- 
lation decreased. But the experience of the chief nations of the 
world during the last sixty or seventy years points to an opposite 



342 PRACTICAL ECONOMICS 

tendency. As a result of the industrial revolution that ushered 
out the eighteenth century the wealth of the great nations has 
been enormously augmented, all classes have been enriched, real 
wages of labor are higher than ever before. The spring has been 
released yet the birth rate has failed to respond; in fact, it has 
decreased as wealth has increased. 

The turn in the tide did not take place for the majority till 
the latter half of the century. France it was that led the way to 
the very beginning of the century. During the last fifty years 
France has several times found it necessary to stimulate the 
growth of her population and is today offering bounties to 
women bearing two children or more, legitimate or illegitimate. 
In 191 L the deaths exceeded the births and under the strain of 
war the reproductive powers of the nation again failed to keep 
pace with death. France may be in no danger of race suicide but 
assuredly there are no signs of a tendency for population to ad- 
vance so rapidly as to encroach upon the means of subsistence. 
Vital statistics indicate that the chief civilized nations of the 
world are following hard on the heels of France. 

The changed economic and social conditions of modern civil- 
ized life, the rise in the standard of living, the goading of am- 
bition, increased knowledge, the drift toward the cities, all tend 
to strengthen the action of the preventive check. If it be true 
that it is the tendency for man in his natural or crude state to 
increase his numbers until checked by famine, war and disease, 
it would seem to be the philosophy of civilization that prevention 
is better than cure. Rather a smaller number and that number 
better fed, clothed, educated and provided with a larger pro- 
portion of the things that make life worth while, than a horde 
of underfed, ill clothed, ignorant creatures destined to a pitiless 
struggle for a bare existence. Instead of blindly increasing and 
allowing nature to check his numbers in her own crude and cruel 
way, man is controlling his own increase. The population in 
civilized countries today no longer presses on subsistence, but 
instead the standard of living presses on the population. Nature 
no longer checks man; man checks nature. 

The standard of living exerts a dual influence on wages; first 
by restraining the growth of population as a whole or in the case 



WAGES— FACTORS ON THE SUPPLY SIDE 



343 



of a particular class by tending to limit the supply of labor. 
Second, as has often been pointed out, it influences the bargaining 
power of the workers by stiffening their backs against a reduc- 
tion in wages below that which they consider essential to main- 
tain them in their accustomed mode of living. But the standard 
of living is not a fixed thing; it is based on desire the nature of 
which is to grow and through ambition it may exert a positive in- 
fluence on wages by stimulating the worker to secure an advance. 



GROWTH OF POPULATION— EXTERNAL 

The spectacular growth of the United States of America was 
one of the wonders of the nineteenth century. It is scarcely con- 
ceivable today that this great country with its hundred and five 
million inhabitants, numbered a little over a century ago less 
than four million souls. 

Table VI. — Growth of Population of the United States 





Population of 


Per- 




Population of 


Per- 


Census 


U. S. Exclusive 


centage 


Census 


U. S. Exclusive 


centage 


Year 


of outlying 


of 


Year 


of outlying 


of 




possessions 


Increase 




possessions 


Increase 


1790 


3,929,214 




1860 


31,443,321 


35.6 


1800 


5,308,483 


35.1 


1870 


38,558,371 


26.6 


1810 


7,239,881 


36.4 


1880 


60,155,783 


26.0 


1820 


9,638,453 


33.1 


1890 


62,947,714 


25.5 


1830 


12,866,020 


33.5 


1900 


75,994,575 


20.7 


1840 


17,069,453 


32.7 


1910 


91,972,266 


21.0 


1850 


23,191,876 


35.9 


1920 


105,683,108 


14.9 



Needless to say this rapid growth was not wholly due to the 
natural increase of births over deaths but largely to immigra- 
tion. During the last hundred years over twenty-nine million 
inhabitants of the old world sailed the seas to try their fortunes 
in this new Eldorado of the West. From 8,385, in 1820 their 
numbers increased to 1,026,499 in 19.05 and before the war cut 
their coming, they were streaming in at the rate of over a million 
a year. In the past this country has had ample land to accom- 
modate this vast perennial influx but it is evident that if the 
same rate of coming were to be maintained during the twentieth 
century overcrowding must eventually result. The density of 
population of the United States increased from 4.5 to the square 



344 PRACTICAL ECONOMICS 

mile in 1790 to 30.9 in 1910. We are still fortunately situated in 
comparison with the older nations of Europe. France has a popu- 
lation of 191 to the square mile; the United Kingdom 379; the 
German Empire 324; Italy 331, while crowded little Belgium has 
673 to every square mile. But while there is still plenty of elbow 
room in this great country, the days of abundant free land are 
gone ; and we talk today of the necessity of conserving our once 
apparently illimitable natural resources. Indeed, it is even 
whispered that the cost of our food is already being raised by the 
action of that arch enemy of growing populations, the law of 
diminishing returns. In recent years the number of immigrants 
arriving in this country has been strictly limited by law. During 
the fiscal year ending June, 1920, 430,000 passed through our 
gates at Ellis Island. An unusually large exodus of emigrants 
took place, however, 288,315 leaving an excess of immigrants of 
193,514. 

Immigration like the standard of living does not affect all 
classes of the population equally. During the earlier part of the 
nineteenth century the majority of our immigrants came from 
the United Kingdom, Germany and Northwestern Europe, lat- 
terly Southern Europe has been furnishing us with the great 
part. The large majority of these are of the lower classes; in 
1913 269,000 were illiterate. Of the 376,776 Italians who im- 
migrated to the United States in 1914, over 28 per cent were 
agricultural and 29.4 were day laborers. While immigration 
adds to the number of professional and skilled workers, it in- 
creases most of all the supply of unskilled labor. 

The immigration question is plainly not one merely of num- 
bers but of kind. The wisdom of admitting into the population 
a large element whose standard of living is below that of the na- 
tive born has been doubted. So far the country's capacity for as- 
similation does not seem to have been seriously strained. A more 
real though more subtle danger from a continuous influx of immi- 
grants is the maintenance of a stratum of population to perform 
the rough labor of the nation, which though its numbers would 
be changing, would itself be permanent and possessed of a stand- 
ard of living below that of the native American laborer. Such 
a condition must inevitably result in lowering the dignity of 



WAGES— FACTORS ON THE SUPPLY SIDE 345 

labor in the eyes of the native American in much the same 
manner as it was lowered by slavery in the eyes of the South- 
erner. A wise immigration policy will seek not only to regulate 
the number but the character of the immigrants admitted, dis- 
criminating between not only the fit and the unfit morally but 
the fit and the unfit industrially, encouraging those classes for 
whose labor there is a demand, and discouraging those of a kind 
of which there may be already an oversupply. 

SUPPLIES OF DIFFERENT KINDS OF LABOR 

We have used the term "labor supply" in a loose and general 
sense. For there are as many different kinds of labor as there 
are different sorts of land, and the quantity of each kind that is 
forthcoming at given prices constitutes its supply. The labor 
supply of a country consists not of one homogeneous supply but 
of a number of separate supplies of different kinds of workers. 

For the sake of convenience these are often divided into groups 
or classes. The various kinds of common labor may be included 
under unskilled labor. Next in order comes the great army of 
semi-skilled workers. Skilled mechanics of all kinds form a class 
by themselves. Leaving the factory, we might class together the 
rank and file of office workers including salesmen and others who 
work out of offices. The general run of professional men, doctors, 
lawyers, artists, engineers, etc., constitute a distinct class. About 
on a par with these are the smaller executives ; the heads of de- 
partments in the big corporations and the officials or owners of 
smaller concerns. Last but not least, we come to the real 
aristocrats of labor, the big business executives, the Garys and 
the Morgans with whom we might include the Charlie Chaplins 
and the Carusos and other eminently successful and productive 
members of the professional classes. Each of these classes con- 
tains a number of distinct occupations and the question is what 
are the chief factors limiting the numbers of workers entering 
these. 

NATURAL ABILITY 

In the unskilled and semi-skilled groups, the numbers are more 
directly dependent on the growth of population, and in the 



346 PRACTICAL ECONOMICS 

United States are especially influenced by immigration. But m 
the skilled and professional classes, the supply of workers avail- 
able in any occupation, is limited by other factors, among the 
most important of which are native ability, education, and social 
environment. The importance which scientific management has 
attached to the selection of men for even the most menial tasks, 
such as handling pig iron and shovelling, show that some natural 
aptitude is requisite for the proper performance of any kind of 
labor. But in general, of course, it is true that whereas there 
are many fitted for those humbler tasks, there are comparatively 
few gifted with the high degree of intellect and personal ability 
which are demanded for handling big business or for exceptional 
success* in the professions. For one Goethals able to engineer 
a project of the proportions of the Panama Canal, there are a 
thousand who could only handle a shovel. Certain kinds of 
work, such as illustrating for advertising, requires special types 
of ability possessed by comparatively few. Natural aptitude 
and hereditary ability place a limit on the supplies of those 
eligible to fill positions of this sort. 

EDUCATION AND TRAINING 

But it is the difficulty and expense of securing the necessary 
education and training which acts as the great check on the num- 
bers entering the trades and professions. To apprentice a boy to 
a trade requires a financial sacrifice on the part of the parents 
as well as patience and pains on the part of the apprentice, while 
preparation for a professional career is today a long, drawn out 
and expensive matter. It is not only the expense involved but 
the time and effort. Were all kinds of higher education made 
free as far as tuition goes, the lure and necessities of the present, 
and the continuous effort over a number of years, that must be 
put forth to complete a full medical, engineering or other pro- 
fessional course, would still serve to limit the number availing 
themselves of it. 

The tendency all along the line is for the professional schools 
to raise their entrance requirements and extend the length of 
their courses. Many medical schools which a few years ago ad- 
mitted students straight from high school now require two years 



WAGES— FACTORS ON THE SUPPLY SIDE 347 

college or even a full A.B.; law and dental schools are following 
suit. Business itself is rapidly becoming a profession in that 
those who aim to fill all but the most lowly positions must obtain 
some perliminary training, while the younger generation enter- 
ing the business arena is being equipped with almost as thor- 
ough a training in the new schools of commerce of our uni- 
versities, as their brothers entering the older professions. The 
trend in our new schools of business administration is toward 
extension of the course from two years to four. In the realm 
of accounting most states require those eligible for the C. P. A. 
examinations to have had a high school course in addition to 
the grammar school grades previously sufficient. This raising of 
the educational fences around professional occupations tends to 
restrict the number of entrants, and raise the rates of remunera- 
tion. The cost of preparing for a trade or profession acts in a 
somewhat similar manner on the price of labor as the cost of 
production on the price of commodities. The professional re- 
muneration must be sufficient to offset the cost of preparation or 
the supply of those entering will decline. In those occupations 
demanding a lengthy and expensive training, earnings will tend 
to be higher because of the fact that the number fitted to enter 
them is limited to the few who have had the necessary general 
and special education. 

How, then, account for the fact that many who possess a fine 
education earn but a pittance whereas others who have never 
seen the inside of a college make fortunes? There may be many 
and diverse reasons; financial success is the resultant of a num- 
ber of forces, any one or more of which may be the determining 
causes. In the first place the difference may be due to natural 
ability or the lack of it. The educated ass is after all but an 
ass and no waving of the educational wand will transform 
him into a lion. Then, too, some who go through college require 
but a diploma and a coat of social polish whereas others who 
have never seen a college campus by intense intellectual effort 
applied to their work and by extensive reading and varied ex- 
perience acquire a genuine and practical education. The edu- 
cation of some college men comes to a full stop with their 
graduation exercises. There are those who believe that an 



348 PRACTICAL ECONOMICS 

academic education though it may make a better man does not 
make a better business man, in that it gives him interests in- 
tellectual and otherwise which are detrimental to the intense and 
narrowly concentrated habits demanded for the accumulation of 
money. This, of course, cannot be said of a technical education, 
or of a college course supplemented by a specialized business 
training. Also the demand in many skilled occupations is small 
and inelastic and oversupply may ensue as a result of undue 
popularity as in the case of trained chemists in Germany. The 
combined efforts of the German government, the universities 
and industry to develop the dye industry and chemical research 
in the years preceding the war, resulted in attracting an ex- 
traordinary number of able men into chemistry. Their numbers 
were so great that the inevitable competition between them for 
positions made the salaries exceedingly small in comparison with 
those received by men of equal ability and training in other 
fields. 

SOCIAL ENVIRONMENT 

Entrance into certain occupations is further influenced by 
social considerations. Class distinctions are less marked in the 
United States than in the older nations yet here as everywhere 
they exist. The majority remain in the class into which they are 
born. The extraordinary man in whatever class will force his 
way to the top but after all, these are the exceptions even in the 
United States. Only the unusually clever or the unusually dull 
will rise or drop out of their respective strata. Born in a favored 
class, surrounded with every care and attention from babyhood 
up, better nurtured, played upon by the subtle influences of a 
cultured home environment through imitation and suggestion, 
well educated and then launched out on his career after gradu- 
ation with the aid of family or social connections; compared 
with the son of a day laborer such a one has a flying start 
in life and must be more than usually stupid to fall to the rear 
in the race. The presumption is that he, like the laborer, will stay 
among his own people. In the course of generations families 
rise and wane like kingdoms but the process is a slow one. 
Social environment means opportunity and opportunity plays 



WAGES— FACTORS ON THE SUPPLY SIDE 349 

a great part in business and professional life. While it is true 
that the higher positions in political, professional and business 
life are possibilities to all classes, they are not probabilities. 
But in the world as it is the majority in the lower classes are 
debarred from ever reaching them. Social environment means 
preferment for some and expulsion for others; it tends to limit 
the number available for many positions. 

INTER-ACTION 

There is considerable difference of opinion as to the relative 
importance of native ability, education and environment. Adam 
Smith expressed the opinion of his time when he said that the 
difference between the philosopher and the porter was chiefly 
due to education, custom and habit. The discoveries of Mendel 
and Darwin have tended to emphasize the importance of 
heredity. Clay, the English economist, maintains that "incomes 
derived from work vary far more than do native ability and 
capacity." "All operations needed to supply all the ordinary needs 
of life have been studied and simplified until any person of ordi- 
nary intelligence provided he has the necessary training can do 
most of them. The opportunity of training and entry into trades 
is then the most important influence and the fundamental reason 
for the difference in the wages of different occupations. Low 
paid occupations are low because they are overcrowded, while 
a high remuneration is secured for an occupation by restricting 
entrance to it." 

Native ability is perhaps the limiting factor for the highest 
positions. As Taussig aptly puts it, "Generals probably are 
born not made. But Colonels and Captains can be trained." 
The supply of generals in the industrial army is limited by the 
rarity of genius, but the limiting factors for captains and colonels 
are more usually education and environment. The abstract 
question as to which is the most important is best left to the 
tender mercies of debating societies. The vital thing to notice 
is that all three play a weighty part in the determination of 
wages. No hard and fast rules can be laid down that will apply 
to all cases or conditions. All three are omnipresent; they act 
and react on each other and sometimes one and sometimes an- 



350 PRACTICAL ECONOMICS 

other is the determining factor. To the individual in his little 
day education and environment in that they are more or less 
under his control are worthy of more practical consideration. 
As someone has said, we cannot choose our parents but we can 
pick our environment. The easier this is made in any nation, 
the freer is education to all, the lower the walls of class distinc- 
tion, the more nearly will differences in wages tend to correspond 
to differences in natural ability. And if it be true, as it 
probably is, that the ability required for the performance of the 
great majority of tasks is possessed by the great majority of 
folks then there will be a tendency toward a greater equality of 
earnings at a higher general level. 

ORGANIZED CONTROL OF THE DEMAND AND SUPPLY 

OF LABOR 

Under conditions of perfectly free competition on both sides, 
the price of a commodity or service is said to be determined by 
the natural action of the law of demand and supply. Rarely to- 
day is anything bought and sold under such conditions. Usually 
there is some agreement or combination on the part of either 
buyers or sellers or of both. Any such control over the demand 
or the supply constitutes interference with the natural action 
of the law. And if the control is sufficient to influence value, the 
price can no longer be said to be determined by the natural action 
of demand and supply but is regulated by monopolistic control 
on the part of either the buyers or the sellers. If both the supply 
and the demand is under absolute monopolistic control, then the 
price will be set by bargaining. Where competition is perfectly 
free, the natural interaction of the forces of demand and supply 
tend to establish an equal price, a fair price in that it satisfies 
both sides. But in the world as it is today free competition 
seldom exists and organized control of the forces on one side or 
the other places the fixing of the price more or less in their 
hands and they come under a strong temptation to disregard 
the interests of the other side and set the price high or low 
according as they may be sellers or buyers. And the rather 
humorous thing is that if any objection is raised and govern- 
mental interference is proposed the manipulators loudly assert 



WAGES— FACTORS ON THE SUPPLY SIDE 351 

the divine rights of the law of demand and supply, and bitterly 
assail any interference with its "natural" action. Where, how- 
ever, the forces on both sides are organized, both meet on an 
equality; and an amicable and fair price is again the natural re- 
sult. 

The demand for labor today in many occupations is largely 
an organized demand. The employer may be an individual but 
in these times of large scale organization he is apt to be a big 
corporation, employing thousands of men, perhaps, as in the 
ease of the United States Steel Corporation, controlling a large 
proportion of the workers employed in one industry. But even 
if there are only a few big employers of labor in one trade and 
there is perfectly free competition between these for men, 
monopoly cannot be said to exist. Just as soon, however, as these 
big concerns combine for the purpose of. hiring men, and act 
together making agreements as to what they will or will not pay, 
free competition between them disappears and in its place comes 
an organized demand for labor. This is made possible in in- 
dustries today by the existence of the numerous kinds of em- 
ployers' associations. The various forms of monopolistic 
agencies previously described place in the hands of employers 
a control over the demand for labor similar to that which they 
exercise over commodities. Not only are the employers in one 
branch of industry organized but by means of their general 
associations such as the National Manufacturers' Association, 
they are capable of concerted action as a whole. 

It follows that if labor remains unorganized under such condi- 
tions, it must ever be at the mercy of capital. It is, of course, 
not necessarily a case of warfare; neither the organizations of 
capital nor of labor are designed primarily for fighting but 
for legitimate and useful purposes. Organization nevertheless 
places a dangerous power in the hands of one over the other 
when that other is unorganized. In the first place even when 
it is a case of man to man, the worker is at a disadvantage. 
His labor is perishable and cannot be stored like commodities. 
It may be withheld, but as in the great majority of cases the 
laborer depends on his labor for a livelihood; loafing means 
starvation for himself and family. What is a great loss to 



352 PRACTICAL ECONOMICS 

him may to his em.ployer mean merely the loss of one man 
among many. As a bargainer he is, as a rule, no match for his 
employer in respect to position, education or knowledge of con- 
ditions; he is the under dog. 

Labor's sole hope lies in organization. Only when the workers 
are organized will they be enabled to meet their organized em- 
ploj^ers on an equal footing in the bargaining process. Through 
their organization they can maintain a reserve fund to permit 
them exercising their inalienable right of withholding their prod- 
uct when not offered what they consider a fair price. They may 
also follow their employers' example and maintain paid repre- 
sentatives at the state and national legislatures to protect and 
advai;ce their interests in respect to legislation. They are en- 
abled to sell their labor through skilled representatives even as 
the corporations buy it by specialists trained for that purpose. 
Through their trade union secretary or other representative they 
appear before their employers not as lone individuals but as an 
organized group. The employer risks the loss not merely of one 
man but of many. By means of apprenticeship rules and some- 
times other perhaps more questionable methods, they are enabled 
to regulate the supply of their product to the demand. In all 
this labor is simply falling in line with the inevitable trend of 
the times by substituting collective action for individual. Like 
the entrepreneur, the worker is selling his product through an 
organization. For this purpose as well as for fraternal reasons 
outside of our present discussion, the trade union has come 
into being. 

That labor has a right to organize under our present system, 
there can be no question. If the workers sell their labor in com- 
petition with each other to an organized body of buyers, they 
like the farmers of old must ever be the dupes of the law of 
demand and supply. It is a clear case of a buyer's monopoly. A 
fair wage is imperilled when the employers who represent the 
demand for a particular kind of labor are organized and the 
workers who constitute the supply are unorganized. Both sides 
being organized, they meet on an equality'-, the only just basis 
for a bargain. It is labor's human right to organize; and not 
only their right but their necessity. They do so not to gain a 



WAGES— FACTORS ON THE SUPPLY SIDE 353 

profit but to make a livelihood. Neither does it betoken a very- 
broad-minded attitude on the part of some who have taken 
a conspicuous part in recent business combinations and de- 
claimed loudly against destructive competition in the selling of 
steel and other things, that they should remain blind to labor's 
danger from ''destructive competition" and refuse to recognize 
labor's right to organize. Nor is it a valid argument against 
labor organization, that trade unions or their officials have some- 
times done some things which they ought not to have done. 
Restriction of output or violence are to be deplored for the 
worker's sake as well as for others and should be punished. But 
big business is by no means a saint and on both sides the wrong 
sometimes done is beside the point. Both capital and labor are 
benefitted by organization which when applied to both means a 
more harmonious adjustment between demand and supply, and 
the only true basis for a fair wage under our present large scale 
system of production. 

TEST QUESTIONS 

1. Give a brief account of the Malthusian theory of population. 

2. Explain the action of the three positive checks on population. 

3. Explain the action of the preventive check on population. 

4. What is meant by saying that the population of a country is grow- 
ing at the bottom instead of at the top? 

5. What is the "modern tendency" in reference 'to the populations of 
the chief civilized nations? 

6. Mention some of the considerations entering into a wise immigra- 
tion policy for the United States. 

7. How do natural ability and education affect the supply of labor in a 
given trade or profession? 

8. What effect do trade unions have on wages? 

REFERENCES 

Bloomfield, D., Modern Industrial Movements. Employment Manage- 
ment. 
Bloomfield, M., Management and Men. 

Clay, H., Economics for the General Reader (Chaps. XVI, XVII). 
Cairnes, J. E., Pohtical Economy (Part II, Chap. I). 
Clark, J. B., The Distribution of Wealth (Chaps. VII-XI). 
Davis and Schwartz, B., Immigration and Americanization. 
Edie, L. D., Principles of the New Economics (Chap. VI). 



354 PRACTICAL ECONOMICS 

Ely, R. T., Outlines of Economics (Chaps. XXI, XXII). 

Fetter, F. A., Economic Principles (Chap. XIX). 

Gantt, H. L., Organizing lor Work. 

Jenks and Lauck, The Immigration Problem. 

Jevons, W. S., Theory of Political Economy (Chaps. V, VIII). 

Kimball, D. S., Plant Management (Alexander Hamilton Series). 

Leverhulme, Lord, The Six-hour Day. 

Marshall, A., Principles of Economics (Book 6, Chaps. Ill to V). 

Mitchell, J., Organized Labor. 

Moore, H. L., Laws of Wages. 

RuBiNOW, I. M., Recent Trend of Real Wages, American Economic Review, 

Vol. IV, pp. 793-817. 
Seligman, E. R. a.. Principles of Economics (Chap. XXVI). 
Smith, A., Wealth of Nations (Book 1, Chap. VIII). 
Streightoff, T. H., The Standard of Living. 
Taussig, F. W., Principles of Economics (Chap. XLVII). 
Walker, F. A., The Wages Question. 
Problems of Population and Parenthood: Second Report National Birth 

Rate Commission of Great Britain. 



CHAPTER XXVIII 
INTEREST 

From the point of view of distribution interest is the share of 
the joint product of industry paid for the use of capital. Just as 
rent is paid for the use of land, interest is paid for capital. 
Because of the service capital performs in our industrial system, 
those who borrow it are able and willing not only to return it 
intact at the close of the period of the loan but to add something 
extra out of the profit they have derived from its use. Not only 
is the payment of interest justified by the service the borrowed 
capital renders but it is necessary to induce the supply of surplus 
wealth demanded by our economic system for the purpose of 
production. Capital is not furnished freely by nature in 
unlimited quantities like air, but is brought into existence at an 
expenditure of labor and saving; therefore, some stimulus is 
necessary to insure an adequate supply and to induce those who 
possess it to abstain from its use and loan it to others. In other 
words capital has value for the same reason that other things 
have, for its scarcity on the one side and its utility on the other. 
Its price or the rate of interest is determined by the supply of 
capital in relation to the demand for it. 

THE RELATION BETWEEN THE LOANABLE CAPITAL 
FUND AND CONCRETE CAPITAL GOODS 

We have already shown how capital comes into existence by 
labor and saving. Capital consists of the products of past in- 
dustry saved and used for the purpose of further production. 
The fact that this saving is represented today by money makes 
it necessary to point out more clearly the connection between 
the money savings and the actual capital wealth saved. All 
money savings come from the money incomes of the people, from 
rents received by owners of land, from the wages of workers, in- 

355 



356 PRACTICAL ECONOMICS 

terest of owners of capital, from the profits of entrepreneurs. 
These instead of receiving their shares of the commodities they 
have assisted in making, in kind, are paid with money. Part of 
this money they spend for commodities and services to satisfy 
present wants. To society the amount thus spent on consump- 
tion goods measures the value of actual wealth consumed. But 
the amount they refrain from spending measures the value of 
actual wealth saved. This money and currency saved consti- 
tutes the capital fund of the nation. Part of it is reinvested 
by those who have saved it in their enterprises. Part of it is 
deposited in commercial or savings banks, paid as premiums to 
insurance companies, to building and loan associations or for 
the bonds of municipalities, railroads or industrial corporations, 
is loaned through these agencies of investment to business men 
who ultimately exchange it for concrete capital goods. It is thus 
evident that the origin of the money and credit which constitutes 
the loanable funds of the nation is the supply of actual wealth 
produced by the community and saved. The loanable capital 
fund simply represents and measures the value of concrete cap- 
ital goods. 

THE SUPPLY OF MONEY AND THE RATE OF INTEREST 

The supply of loanable capital funds depends on the quantity 
of actual wealth saved. This needs to be emphasized because 
of the erroneous though very plausible belief that the supply 
of money and credit is the supply of capital and its extent de- 
termines the interest rate. But the total supply of money and 
credit is by no means identical with the supply of loanable cap- 
ital funds. A large part of the former is required for consump- 
tion purposes and only that part is available for loaning which 
is not required for present spending. An increase in the quan- 
tity of money and credit means higher prices; a decrease results 
in lower prices, and it is chiefly by reason of the effects of rising 
and falling prices on the supply and demand for capital that the 
interest rate is influenced by money and credit. The temporary 
effect of an increase in the monetary supply would indeed be a 
lowering of the rate of interest but a continued increase results 
in raising it. As we saw when studying prices a period of rising 



INTEREST 357 

prices stimulates business enterprise. This increases the demand 
for capital and tends to raise the rate of interest. The opposite 
is true as a result of a continued decrease in the supply of money 
and credit. Falling prices discourage enterprise and decrease 
the demand for capital. As stated by that eminent authority on 
money Joseph French Johnson^: "If the adjustment of prices 
is perfect, the supply of money not being increased except to 
meet an increasing demand, the rate of interest will be entirely 
independent of the amount of money in existence. The saving and 
productive capacity of a people upon which the rate of interest 
depends, is not a product of the money supply, but of their thrift 
and energy and of the country's natural resources." 

SAVING AND THE SUPPLY OF CAPITAL 

The supply of loanable capital depends on saving. What, then, 
are the influences governing the savings of a nation? The new 
capital of a nation is drawn from two main sources. A large 
part, much larger than is usually supposed, is derived from the 
reinvested surpluses of business concerns. According to the esti- 
mate of David Friday ^ based on an analysis of the net incomes 
of all corporations in the United States, the total capital from 
this source in 1919 was placed at $2,800,000,000. The balance 
of the nation's new capital depends on the savings of individuals. 
The total savings for 1919 from all sources from all business con- 
cerns including the reinvested savings of farmers and from in- 
dividuals were estimated by Friday at $15,000,000,000. The 
ability and willingness of people to save depends on the amount 
of their incomes and their thriftiness. A minimum income suffi- 
cient at least to satisfy the vital necessities of the present is a 
prerequisite to any saving at all. Savings come out of surplus 
and it is obvious that a bare subsistence leaves nothing to save 
from. Present needs have a preferred claim on income, the 
future can lay claim only to the excess above the minimum re- 
quirements of the present. The very poor are by stern necessity 
compelled to live from hand to mouth ; safety deposit boxes and 

For a detailed explanation of the relation between money and the rate 
of interest see Joseph French Johnson's "Money and Currency," which is 
the most able and brilliant work written on that subject by an American. 
2 "Profits, Wages and Prices". 



358 PRACTICAL ECONOMICS 

bonds exist not for them. In every country there is a substratum 
of the population living in this condition. These, it is evident 
by virtue of their poverty, are ruled out from contributing to the 
capital funds of the nation. Not much better off in regard to 
the mere ability to save even in this the most favored land of 
the worker is the rank and file of the laboring and lower paid 
portion of the clerical classes who though their incomes are with- 
out doubt above a bare subsistence, yet admit of scant opportu- 
nity to save except to the most thrifty. They do indeed save 
temporarily, but their two dread enemies, sickness and unem- 
ployment, wipe out their little stores as fast as they gather them 
together. Like "Alice in Wonderland," with all their running 
they get> nowhere. On the other hand the very rich with incomes 
far in excess not merely of their needs but of even their lavish 
wants, save large sums with ease. The accumulations of this 
class probably furnish the major part of the capital funds of the 
nation. Between these extremes whose savings or lack of sav- 
ings are conditioned chiefly by the size of their incomes lies the 
great mass of the middle classes, the extent of whose accumula- 
tions depend more on their willingness to save than their mere 
ability, on their thriftiness rather than the size of their income. 

In turning from the material to the psychological side of sav- 
ing we find its essence to be a conflict between present and future 
wants. To the great majority saving involves sacrifice, the 
abstaining from the satisfaction of present wants in order to 
provide the means for supplying a future satisfaction. This is 
the essence of thrift. In order to save up for a home or for old 
age the thrifty deny themselves daily. Psychologically it re- 
solves itself into the balancing of a want for a present good, 
intensified perhaps by a strong appeal to the senses, against the 
colder, intellectual desire for something in the future. 

One of the first secrets of thrift, then, is the ability to control 
present wants. This some people never learn to do. Needs have 
their limit but wants are of infinite elasticity. No matter how 
large the incomes of some they never have more than enough 
to live on. The wants of the majority increase as fast if not 
faster than their earnings. Thousands have found it more diffi- 
cult to save on an income of $5000 than when they were earning 



INTEREST 359 

less than half that sum. An excellent plan, but one seldom 
adhered to by those starting out on their careers, is that of bank- 
ing one-half of all increases in earnings. This fifty-fifty plan of 
division between present and future if generally practiced would 
bring modest fortunes to thousands who are now drifting toward 
a penniless and dependent old age. That large, happy-go-lucky 
class whose hearts all beat to the fond belief that they "have 
nothing to save" include the man with $18,000 as well as his 
poorer brother with $1800. And though each honestly feels 
that if he were only receiving a couple of thousand a year more 
he would surely have a safe deposit box bulging with bonds the 
human likelihood is that his wants would bulge faster than his 
income. The rare art of saving as the sage would put it de- 
pends not only on the greatness of one's wealth but on the few- 
ness of one's wants. 

But if the control of present wants constitutes the negative 
side of saving, the positive side consists in the cultivation of 
wants for the future. These furnish the motive power for 
saving and are the products of the imagination. Foresight is 
the mainspring of thrift. In no other power do men vary more 
than in their ability to visualize the future. The degree in which 
this important faculty is possessed is to a large extent the 
measure of the modern man. Many there are who fail to show 
even a trace of the instinct that teaches the dog to bury his 
bone and the squirrel to secrete his winter store of nuts. The 
southern darky is perfectly happy as long as his body is warm 
and his stomach filled; others look but a few days ahead. Still 
others, founders of families, builders of big industries, states- 
men, plan for generations unborn. Such men as the Astors, the 
Hills and Harrimans, the Vails and the Roosevelts, gifted with 
vision into the distant future, tower above the shoulders of the 
multitude. 

Foresight marks both the development of races and indi- 
viduals. Young races as well as young people live mainly in the 
present. The logical time to save is in youth or middle age when 
energy is at its zenith, but the natural time seems to be toward 
the tail end of life when oncoming old age begins to herald its 
approach by decreased vigor or twinges of rheumatism. Not 



360 PRACTICAL ECONOMICS 

till most men get well into their forties ao they realize the neces- 
sity of some provision for old age. They are then in such a 
hurry that instead of investing they take to speculation and end 
up by losing all they ever had. 

With the average man and in particular the average young 
man present wants are dominant not merely because they largely 
spring from the bodily appetite but because they are reinforced 
by the seductive appeals of the senses. What the eye sees the 
mind is apt to want. This natural fact makes saving in the 
city harder than in the country. The city dweller undergoes a 
continual bombardment through the senses from the attractive 
wares displayed in store windows and in use by passers-by. He 
and in particular his wife live in a most tantalizing atmosphere 
of temptation. They are forever seeing something they want 
which in all likelihood they wouldn't have wanted had not they 
first have seen it. It is different with future things, such as 
next year's vacation, a home of one's own or provision for old 
age; these are not as a rule visible to the physical eye but to 
the eye of the mind which alone has the power of peering into 
the future. More than on any other one thing thrift depends 
on imagination, the faculty by means of which all ideas are cre- 
ated including those which embody wants for the future. 

A third requisite to thrift is will-power. Saving is a Marathon 
race in which many start but few finish and the reason is the 
same in both cases, namely, lack of staying power. Will-power, 
according to modern psychology, is the ability to keep an idea 
permanently in mind. Most people start out to save for some- 
thing or other at one time or another but the failure of their 
savings actually to materialize is commonly due to the lack of 
permanence of their wants for future things which are ousted 
from their minds by the flow of new wants borne of the ever 
recurring present. The present is always with us, the future 
ever beyond. Saving necessititates the keeping of an idea per- 
manently in the mind. It involves continuous concentration 
upon a single idea. Now a purpose of any kind to be retained 
in the mind in a dynamic state, requires to be fed just as a fire 
under a boiler must be fed or it ceases to generate sufficient 
power to produce action and finally dies out. The most com- 



INTEREST 361 

mon reason why men fail to achieve in saving and in the larger 
field of life itself is because they fail to maintain the desires on 
which all achievements depend for their motive power. 

Finally, a definite plan of saving is a great aid. Here a num- 
ber of institutions, savings banks, insurance companies, building 
and loan associations, fraternal organizations and clubs of 
various kinds perform a useful function in aiding would-be savers 
to save regularly according to some prearranged plan. The ar- 
rival of the baby bond and the installment plan of purchasing 
securities make it possible for almost anyone who wills to save 
easily and systematically. 

Of course, saving like every other virtue is capable of being 
carried to excess, but with human nature as it is, and in the 
face of statistics which indicate that 93 per cent of those reaching 
the age of seventy-five are dependent on work or charity for their 
support and 90 per cent of the population die intestate, there is 
little danger of erring on the side of thrift. He who saves not 
only confer-s a benefit on himself but on the nation which he 
assists by supplying it with capital for productive purposes. 
This lesson requires to be driven home for the sake of society 
at large and of the individual, whose interests in this case are 
parallel. It is no credit to the United States that it ranks as 
low as fifteenth among the nations in the percentage of savings 
accounts to population. The necessity and advantages of thrift 
should be taught in the schools but in the absence of this every 
man who is interested in getting along in the world should see 
to it himself that he is fully alive to the value of saving. The 
words of James J. Hill along this line are well worth quoting: 
'Tf you want to know whether you are destined to a success or 
not you can easily find out. The test is simple and infallible. 
Are you able to save money? If not drop out. You will lose. 
You may think not but you will lose as sure as fate for the seed 
of success is not in you." 

SOURCE OF THE DEMAND FOR LOANABLE CAPITAL 

FUNDS 

In turning from the side of supply to that of demand in order 
to see the real forces that determine the interest rate it is also 



362 PRACTICAL ECONOMICS 

well to emphasize the fact that the source of the demand for 
capital funds is the productivity of concrete capital goods. It is 
often said that "money breeds interest." This, of course, is true 
in a superficial sense, but as an explanation of the payment of 
interest it stops short of the main facts. The real reason that 
money is able to breed interest is because business men by means 
of it can secure buildings, machinery, materials, land and labor 
which under their management produce a greater amount of 
wealth than they originally cost. Out of this extra wealth in- 
terest is paid for the use of the money with which these pro- 
ductive capital goods were obtained. It is obvious that gold 
or dollar bills cannot grow corn or make shoes. But they do 
enable 'the farmer to procure the seed and the shoemaker the 
machinery by means of which they are able to produce corn and 
shoes. It is purchasing power which is borrowed and purchas- 
ing power that is returned, but it is out of the productivity of 
what is purchased that interest is paid. The true source of 
interest is thus the productivity of capital goods. The manner 
in which these aid production has already been explained. 

In its broadest sense interest is the payment made for a loan 
of wealth. We have only spoken of wealth loaned for productive 
purposes. Money is often borrowed for public or private con- 
sumption. Governments, municipalities and private individuals 
borrow for the purpose of spending to satisfy present wants and 
are willing to pay back more than they borrowed. In olden 
times when most borrowing was for immediate use, arising out 
of the necessities or misfortunes of the borrowers whose urgency 
was often taken advantage of by unscrupulous money lenders 
as it still is today, the payment of interest was looked at ask- 
ance and condemned by religion, law and public opinion. While 
the exaction of an exorbitant rate of interest is, of course, to be 
deplored, there is no just reason why a person who borrows the 
wealth of another and uses it for his own ends should not pay 
for that use. The reason of the prejudice against usury, as it 
was termed, apart from the aversion to the practice of extortion, 
was the failure .to see the real source of the payment. It was 
money that was borrowed and money which was paid back; and 
as Aristotle long ago pointed out money cannot itself make 



INTEREST 363 

more money, hence there could be no legitimate reason why the 
lender should demand back more money than he loaned. The 
source of the service performed by the money borrowed is derived 
from that which is purchased with the money or to be strictly 
accurate the want it serves to satisfy. And the reason the bor- 
rower is anxious to borrow and willing to pay interest springs 
from the fact that his present needs are of a greater degree of 
intensity than those of the future. On account of this psycholog- 
ical fact, a stipulated sum of money in the present possesses 
greater utility than the same sum a year hence. $100 for pres- 
ent use is worth $105 a year hence. The $5 interest represents 
the difference between the utility of present use of the money 
and the estimate of its future utility. The loaning of money is 
a productive act in that it transfers wealth from the possession 
•of one person to another to whom it has greater utility. This 
is especially true in the case of sickness or temporary misfor- 
tune where the need for present wealth is urgent and more enter- 
prises of the sort recently established in New York on the Morris 
plan whereby needy people are able to borrow on their personal 
credit at a reasonable rate are to be desired. Part of com- 
mercial rent as already explained is in reality interest, being a 
return for the capital invested in the land in the form of houses 
or other improvements. In all cases whether the wealth loaned is 
applied to the production of future commodities or to satisfy 
the more pressing needs of the present, interest springs from the 
service the use of the loan confers on the borrower. 

THE RATE OF INTEREST 

The rate of interest will be determined by the marginal cost 
of saving on the supply side and on the demand side by the 
marginal productivity of capita goods. A large amount of saving 
would take place without any payment of interest and it is 
perfectly conceivable that the surplus wealth of a nation might 
exceed that required. The interest rate in Great Britain to- 
ward the latter part of nineteenth century dropped for a time 
below 1 per cent. But as things are, some payment is necessary 
to induce a supply sufficient to satisfy the demand. The march 
of progress, invention and the extension of business enterprise, 



364 PRACTICAL ECONOMICS 

not to speak of wars, which are agencies of destruction, all tend 
to increase the demand for capital. It is the marginal part of 
the supply that would be lacking if no payment were offered. 
A rate of interest just sufficient to induce this portion of the 
supply must be paid. With no inducement at all a large accumu- 
lation of wealth would take place. A rate of 2 per cent would 
increase the amount but not sufficient to supply existing need. 
To insure the quantity required a higher rate, say 4 per cent, 
must be paid. This payment is just sufficient to make it worth 
while for the marginal savers to save the extra quantity required. 
This rate constitutes the supply price of loanable capital. 

The demand price will be determined by the least profitable 
use to which the supply can be put. Some business men will be 
willing to pay a high rate of interest on account of the pro- 
ductivity of their enterprises. Were the rate say 10 per cent, 
rather than go without they would willingly pay it. But the 
amount of capital demanded at this high rate would only find 
employment for a small portion of the existing supply. A rate 
of 6 per cent would increase the amount demanded by making 
it worth while for more concerns to borrow and others to borrow 
more. While a rate of 4 per cent would make the demand about 
equal to the supply. This rate on the demand side would be 
equivalent to the least profitable use made of the borrowed cap- 
ital and represents the productivity of capital at the margin. 
On the supply side it is equivalent to the marginal cost of saving. 
Should the rate of interest go any higher, the supply of loanable 
capital will increase because of the extra inducement to save 
and at the same time the demand would fall off with the result 
that the rate will tend to fall. Should it fall below this equilib- 
rium rate saving will be discouraged, enterprise stimulated and 
the rate would tend upward. Interest is the price paid for a 
loan of wealth and like any other price except that of land, it 
is based on marginal cost on the one hand and marginal utility 
on the other. 

We have spoken of the rate of interest because there is a 
tendency toward a general rate. Capital differs from land or 
labor in its degree of mobility. The loanable capital of a nation 
and of the world for that matter exists as a fund of money and 



INTEREST 365 

credit which flows readily from one occupation or place to an- 
other. Competition on the one hand by business men in different 
industries and places for its use, and on the other hand by those 
who own or control it to obtain the highest rates for it tend to 
equalize interest rates of loans within a nation and even between 
different countries. This does not mean that all forms of loans 
bring exactly the same rate but there is a tendency for the same 
kind of loans in any one country and for some kinds in all coun- 
tries to be nearly equal. Capital in the form of money flows 
toward the most profitable market. If the rate is higher in New 
York than in London loanable funds flow to New York and the 
increased supply there tends to lower the rate. The same is 
true of individual industries. If the earnings in one industry are 
greater than another, capital will be attracted to it. After a 
time the increased supply will lower the earnings and the rate 
of interest will fall toward the general lead. 

Differences in the rate of interest are often due to other 
elements outside of pure interest which, strictly speaking, is the 
payment for the use of capital only. "Gross interest" may con- 
tain payments for management or storage as in the cost of 
pawnbrokers' loans, or for repairs and replacement as in the 
case of that part of commercial rent paid for improvements 
which as before stated is strictly interest. Risk exerts a great 
influence on interest. The greater the risk as a general rule the 
higher the rate of interest. This is a truth that investors, espe- 
cially amateur investors, would do well to paste in their hats. 
Safety of the principal is the first consideration in investing; as 
high a rate of interest as possible the second. The reversal of 
this order often leads to the loss of both principal and interest. 
This, of course, is not always the case but often enough for the 
rule to stand. On account of safety the governments of the 
great nations, well known municipalities and railroads are able 
to borrow at a lower rate than industrial concerns. British 
"consuls" and United States bonds are as safe as is humanly 
possible. Municipalities seldom fail to meet their obligations. 
Railroads must run. This element of payment for risk is in 
effect compensation demanded by the lender on account of 
danger of loss to his principal. Distance also affects interest 



366 PRACTICAL ECONOMICS 

rates. Those localities or small countries far from the capital 
centres must usually pay a higher rate of interest. Their enter- 
prises may be just as safe in reality as those nearer home but 
they are not as well known and hence as a rule they must pay a 
higher rate to induce distant owners of capital to loan them their 
wealth. The same truth applies to small unknown enterprises 
which must often pay a higher rate to secure their funds than 
larger and better known concerns whose securities are listed on 
the big exchanges. 

TEST QUESTIONS 

1. Distinguish between the supply of money and the supply of capital. 

2. Name the different sources of new capital. 

3. What are the factors on which saving depends? 

4. What is the source of interest? 

5. Why was interest condemned in ancient times? 

6. Why is it justified today? 

7. What determines the rate of interest? 

8. Why is there a tendency toward a general rate of interest and not 
toward a general rate of wages? 

REFERENCES 

Ashley, W. J., English Economic History. 

Bohm-Bawerk, E. von, Capital and Interest. 

Cassil, G., Nature and Necessity of Interest. 

Clay, H., Economics for the General Reader (Chap. XVIII), 

Edie, L. D., Principles of the New Economics (Chap. VII). 

Ely, R. T., Outhnes of Economics (Chap. XXIV). 

Fisher, I., Capital and Income. 

Conner, E. C. K., Principles (Part IV). 

Jenks, J. W., Great Fortunes. 

Marshall, A., Principles of Economics (Book 6, Chaps. VI to VIII). 

Nicholson, J. S. Principles of Political Economy (Book 2, Chap. XIII). 

PiGOu, A. C, Economics of Welfare. 

Seligman, E. R. a.. Principles of Economics (Chap. XXV). 

Smith, A., Wealth of Nations (Book 2). 

Taussig, F. W., Principles of Economics (Chaps. XXXVIII-XL). 



CHAPTER XXIX 

PROFIT 
WHAT IS PROFIT? 

We now come to the last and most elusive of the shares in 
distribution concerning which there is some difference of opinion. 
In its broadest sense profit is a complex form of income contain- 
ing elements of any or all of the other forms, rent, wages and 
interest. It is the difference between the total expenses of an 
enterpriser or enterprise and receipts. The expenses of a business 
concern are the sums it pays for the other factors, land, labor, 
and capital; these sums constitute the incomes of these factors. 
When the concern hires or borrows the other factors the sums 
paid for their use stand out clearly as rent, interest and wages. 
But when the concern issuing its own land, labor or capital the 
returns to these factors become merged in its profits. The ques- 
tion is, are we to consider all of the balance of the joint product 
of industry retained by the owners of the enterprise as profit or 
shall we analyze it into its constituent parts and count as profit 
only that share not imputable to the other factors whether 
owned by the enterprise or not. And if we are able to distinguish 
a fourth share of income entirely separate from that of land, 
labor and capital, to what other factor is it to be attributed? 
Why should profit be paid? Has it any economic justification 
or is it merely an excrescence, a sort of overflow from the earnings 
of the other factors, illicitly retained by those who employ and 
thus exploit them? 

In business practice that which is considered as profit varies. 
In the case of a tenant farmer, rent is an expense and will not be 
included in his profit, but he may fail to distinguish from the 

367 



368 PRACTICAL ECONOMICS 

balance of his receipts over expenses, separate payments ot 
wages and interest for his own labor and capital. His profit will 
not include rent but might be held to comprise elements of wages 
and interest. If he owns his own land rent will also be included 
in his profits. Should he hire laborers, the wages of these will 
be part of his expenses but he will be likely to lump his own 
wages of management in with his profit. In the same manner a 
small storekeeper owning his property and using his own capital 
might count his total sales after deducting expenses, his profit. 
This is sometimes termed gross profit. Such a course is often 
grossly misleading, for his real profit is likely to be the Dutch- 
man's 1 per cent or less; the tendency is to carry the analysis 
further and at any rate to distinguish rent and wages from 
profits and such a course seems not only good practice but sound 
theory. In partnerships, as Taussig instances, a distinction is 
sometimes made between interest and profit. From the net earn- 
ings there is first deducted an allowance for interest at the 
current rate for the capital used. Salaries for the active partner 
or partners are then paid out of the balance and the remainder 
is divided among the partners as profit. In the corporation form 
of organization the analysis of the different shares is fairly com- 
plete. A distinction is made between borrowed capital and that 
owned by the corporation. Interest on borrowed capital, as on 
bonds or notes, is an expense. The return on capital invested in 
the concern the actual value of which is hard to ascertain is 
included in profits, which are paid in the form of dividends. 
Labor, including the labor of management from foremen's wages 
to directors' fees are all regarded as expenses. Rent for hired 
land is of course an expense, but the practice of listing as an 
expense the rental value of land owned and used by the cor- 
poration varies, usually the profits of corporations contain traces 
of economic rent. 

Whatever profit is or is not, one thing is clear; it is always the 
share paid to the enterpriser or owner of the enterprise. If we 
carry the analysis to the last ditch, after deducting from gross 
profit or net earnings the amounts imputable to land, labor and 
capital owned and used by the enterprise, we still have a residue 
which we may term pure profit. In practice, however, profit has 



PROFIT 369 

no such narrow meaning nor is there any reason in theory for 
so limiting it. If the business enterprise owns its own land or 
capital the returns imputable to these factors belong to it. A 
business organization is comprised of land, labor and capital; 
these factors become merged in it in a new entity and the returns 
likewise become merged into profit. 

Just as economic rent is the share of the joint product paid to 
the owners of land, wages that paid to the laborer and interest 
that paid to the owner of capital, profit is the share paid to the 
owners of the business unit or organization for the part it plays 
in the production of the joint product. It is based on the pro- 
ductivity of organization as a separate factor in production, just 
as rent rests on the productivit}'' of land, wages on that of labor 
and interest on the productivity of capital. The nature of 
organization and the function performed by it we have already 
explained. It is the structural unit, uniting the other factors into 
a producing concern. From the viewpoint of distribution profit 
is the share of the joint product assigned to it for the service it 
renders. 

On the side of supply profit is the supply price of organization 
as interest is the supply price of capital. Capital comes into 
existence as a result of labor and saving, organization as a result 
of labor saving and enterprise. Just as the supply of capital 
depends directly on saving, that of organization depends on 
enterprise. Business enterprise involves responsibility and risk. 
This responsibility and risk will not be undertaken for nothing. 
Profit is its reward and furnishes the incentive necessary to 
enterprise. Men will not undertake the organization of business 
enterprises merely for wages and interest. The primary motive 
for business activity is profit. It is the great regulator of 
industry. If profits are high in any particular branch of business 
or at any period, enterprise is stimulated; if low it is discouraged. 
And under our present system of private enterprise with its 
attendant risks and responsibilities profit is as necessary as 
wages. Under a regime of Socialism with the state shouldering 
the full responsibility of enterprise, or if the millenium were to 
arrive, profit might be dispensed with, but in the world as it is 
profit is not only a justifiable but a necessary payment. 



370 PRACTICAL ECONOMICS 

THE UNCERTAINTY OF BUSINESS ENTERPRISE 

The justification and necessity of profit lie largely in the risk 
and responsibility of business enterprise. Production takes place 
in anticipation of demand. The enterpriser or enterprise esti- 
mates the wants of the community, the prices they will be will- 
ing to pay and then undertakes to satisfy those wants by uniting 
the other factors in such a manner as to produce the commodity 
or service at the estimated price. In so doing he employs the 
other factors, paying for them or contracting to pay them at 
stipulated rates usually in advance of the receipt of the price 
and often before he has knowledge of what that price will be. 
These contracted expenses he must pay. What is left over con- 
stitutes^ his profit. This may be large or small or even nil, 
according as his judgment has been correct or conditions over 
which he has no control may change. If he is able to sell at a 
higher price than he anticipated, his profits are large; but, on 
the other hand, should the demand be less than he anticipated, 
or fall off in the interim, he must be content with a small profit 
or even suffer a loss. When prices rise he is the first to feel the 
benefit; when they fall, the first to feel the shock. Indeed, if 
profit is the most alluring of the shares of distribution, it is 
surely the most volatile. Rent, wages and interest are more 
stable forms of income. The owners of the other factors know 
in advance what their shares will be. They have contractual 
claims on the joint product. The entrepreneur has none. On 
the contrary, should the price of the joint product fall below the 
claims of the others he must make these good out of his own 
pocket. The owners of the other factors prefer a certainty to 
an uncertainty, a smaller, perhaps, but a surer source of income. 
Rather than undertake the responsibility and risk of going into 
business for themselves they prefer to hire or loan their labor 
or capital to others for a fixed return. The entrepreneur shoul- 
ders the responsibility of the enterprise and assumes the burden 
of the risk. His shares lie on the lap of the gods and, though 
it be the lion's share, like the lion he must take the chances of 
the chase. 

Business risk of course varies. It is greater at some periods 
than others and in some businesses. At times of sudden change 



PROFIT 



371 



as at the outbreak or close of a war or the approach of panic it 

is increased. Sudden changes bring in their train big profit and 

Number of Business Failures in United States & Canada 

from 1900-1919 

United States Charted by Thousands. Canada by Hundreds . 

1900'01'02 '03 '04 '05 'OC '07 '08 '09 '10 'U '12 '13 '14 '15 '16 '17 '18 1019 



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1900 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 'U '13 '13 '14 '15 '16 '17 '18 1919 

Fig. 23. 

big losses. Fortunes are made and lost almost overnight. The 
accompanying chart which graphs the annual crop of business 
failures in the United States and Canada from 1900 on shows 



372 PRACTICAL ECONOMICS 

at a glance the effect of change on the hazards of enterprise. 
Note the rise following a panic and how the line is tossed high 
in the air at the shock of war and how fast it recedes in the 
aftermath of rising prices. In periods of rapidly rising prices 
the risk is lessened by the raising of the margin between price 
and cost. In the recent war and post war period the margin was 
elevated to such an extent that the veriest tyro in business, 
however inefficient, made money, while the profits of many 
reached princely proportions. With the turn in the tide in 1920 
this jovial state of affairs suddenly ceased. The tables were 
turned and it became as easy to lose as before to gain. As the 
level of prices fell it sank below the swollen costs of the previous 
period dnd in many places goods must be sold at a loss. As 
the margin narrows, costs must be reduced, a premium is again 
placed on efficiency. The salesman no longer loafs around the 
office hearing the prayers of importunate buyers but is hustled 
off on the road to sell and is soundly berated because he has 
grown "soft." The "easy money" disappears, the crop of failures 
increase, business again becomes business. 

For new businesses or in new industries the risk is greater. A 
large percentage of new businesses fail. Accurate statistics are 
not available. It has been estimated that "nine of every ten 
corporations within ten years from the date of their formation 
have either dissolved, failed, reorganized or been swallowed up 
by other companies." Though it should be noted that the last 
two happenings by no means always denote loss. If we had 
mortality tables for business organizations without doubt they 
would favor those of human beings in showing a high death rate 
during the period of infancy. And there are good reasons why; 
a new enterprise faces many perils both from within and with- 
out, — fraudulent promotion, incompetency or inexperience, in- 
sufficient capital, unforeseen competition or inventions which may 
supersede its product. A new venture is always an uncertainty 
except in the ardent opinions of its organizers and promoters. 
In a new industry during the pioneer stage the hazard is usually 
high and failures and losses frequent. When the preliminary 
experimental stage is passed, when the ground has been cleared 
and the main thoroughfares marked out and the industry get§ 



PROFIT 373 

its stride in the heyday of its youth, opportunities for mak- 
ing money are at their zenith. Such was the steel industry 
in the nineties, the rubber industry shortly after, and such is 
the moving picture industry today. Later on when it settles 
down into staid middle age, its possibilities realized, its 
methods standardized, the risks decrease and likewise the 
profits. In such an industry after competition has burnt 
itself out and the control falls into the hands of one large 
concern or a few who act together keeping up merely a show of 
competition, the risk is reduced to a minimum. Monopoly re- 
duces the risk by virtue of its control over the conditions of 
supply or demand and the price and thus tends to entrench and 
often increase profit. Advertising, also, by reason of its con- 
trol of demand lessens the risk. So, too, does the development of 
the science of organization and management which points out the 
causes of failure and makes known the principles governing the 
successful conduct of enterprises. But all this notwithstanding, 
as long as industry is left to private enterprise and as long as 
change continues in the world, and change is but the working 
out of progress, the conduct of business enterprise will involve 
risk and responsibility on the part of those who undertake them 
and unless human nature itself changes this risk will not be as- 
sumed for nothing. 

In the light of this fact profit performs a most essential and 
useful function in industry. It is at one and the same time the 
alpha and omega of business activity; desire for it is the 
force that fires the spirit of enterprise; realization of it sup- 
plies the reward. It is the invisible current that motivates the 
whole machinery of our economic system. It is the instigator 
of new enterprises and the extender of old. No risks are too 
great for it, no obstacle too big, no sacrifice too much. Curtail 
it and you curtail enterprise, increase it and you stimulate busi- 
ness activity, destroy it and you destroy the very force on which 
progress depends. 

ENTERPRISE IN THE UNITED STATES 

The growth and prosperity of the business organization of any 
nation depend on the enterprise of its people. On what then does 



374 PRACTICAL ECONOMICS 

enterprise depend? The essence of enterprise is leadership. 
Those who undertake the risk and responsibility of launching 
and running a business require in a marked degree the qualities 
of leadership. There are of course many qualities that go to 
make up a leader, chief among which are energy, initiative, 
knowledge, including a knowledge of human nature, constructive 
imagination, confidence and courage, plus the practical faculty 
of getting things done. Any nation breeding men with these 
sterling qualities will never want for leaders in business or any 
other sphere of activity. The conditions of life in the United 
States especially in the early period of its history have been 
such as to foster these characteristics in a marked degree. The 
typical American may be eclipsed in the more cautious quality 
of saving by those of the older races but in enterprise he is 
second to none. No doubt the foundation for this faculty 
was laid in the pioneer days of colonial times and the first 
display of it was the desire to launch out as a separate nation, 
an undertaking that has been eminently successful. National 
character just as that of the individual is mightily influenced 
by early environment. And the cradling of this great nation took 
place amid surroundings that could hardly do aught else but 
foster the qualities of leadership and independence. The pioneer 
life of the early settlers with its unsettled conditions, its close- 
ness to nature, its dangers, its freedom, lack of restraint, of 
conventions and standards, its riches of undeveloped resources 
waiting for the inventive genius of man; all invited enterprise. 
And the men who settled it responded to the call. Little wonder 
at this, for it was the pick of the old world, the adventurer, the 
liberty lover, the possessor of initiative and vision that sailed 
to its shores. Such a union of environment and human nature 
was bound to breed a race possessed of more than common en- 
terprise. And the subsequent development of the country, its 
unparallelled rise in the space of a century to the richest among 
the nations of the earth, with an estimated wealth of $350,- 
000,000,000 is its ample evidence. 

There is no nation today where the spirit of enterprise burns 
more ardently than in the United States. In no other country 
is it so easily possible for any man to launch out for himself. 



PROFIT 375 

No other country has produced greater entrepreneurs, men with a 
higher genius for the organization of land, labor and capital into 
productive enterprises. Such men as Rockefeller in the oil in- 
dustry. Hill and Harriman in transportation, Carnegie and Gary 
in the iron and steel industry. Bell and Vail in communication, 
Westinghouse and Steinmetz in the electrical field, Stone and 
Webster in water power development, Morgan in the realm of 
finance, these and scores of others less well known, are typical 
of the men this country has raised up from the ranks to take 
the lead in the organization of its industrial and commercial re- 
sources and of whom it may rightly be proud. It is true that 
these have not all been angles ; their methods at times have been 
harsh, their personal gains by no means small. But business is 
not exactly a pink tea; at bottom it smacks more of the nature of 
a battle, as the inside history of almost any branch of industrial 
enterprise will reveal. These men are the conquerors, real heroes 
in their respective fields, leaders where leaders have been needed 
and if they have enriched themselves they have more enriched 
their country. Men of their caliber, men gifted with vision; 
men with the courage of their convictions, ready to shoulder the 
risk and responsibility of affairs, men endowed with genius for 
organization, able to mould the forces of industry into productive 
shape on the scale called for by modern methods of large scale 
production, and successfully direct the course of their giant con- 
cerns through the storms of competition and changing conditions 
which sweep every industry during its upbuilding, leaders of this 
type every new country needs and such men are not to be picked 
up on every street corner. Under the guidance of men of this 
type the American corporation as a master-form of enterprise 
has been developed to a high pitch of efficiency, the productivity 
of the country's land, labor, and capital has been increased, and 
its wealth enhanced. The famous ingenuity of the Yankee has 
nowhere been so signally displayed as in the field of business 
organization. 

It may seem to some that freedom of enterprise in the States is 
unduly subject to governmental interference. This country has 
been unfavorably compared with Germany for instance, whose 
government, it is said, encourages and cooperates with business 



376 PRACTICAL ECONOMICS 

while that of the States not only fails to give it the support it 
needs but seems bent on hampering it with unnecessary legal 
restrictions. This has appeared so at times, yet some restriction 
is needed in this country because of the intensely individualistic 
nature of its enterprise, because of its exceptional freedom, lest 
that freedom should develop into license, while on the contrary 
in Germany with its pre-war autocratic form of government 
there was little danger from this source, for the individual was 
entirely subservient to the government which dominated business 
in common with all other activities and the cooperation given as 
in the dye industry was usually to encourage the ulterior policies 
of the government. Such is the power of private enterprise in 
this country today that some control is needed. The corporate 
form of organization with its centralization of control facilitates 
the concentration of power into the. hands of one or a few in- 
dividuals. One, or several acting together on the executive com- 
mittee of a big holding company might with ease control a 
whole industry, or a few men controlling big corporate interests 
by collusion might dominate several industries. There are men 
in the United States today who hold in the hollow of their hands 
more power over their fellows than ever did the feudal barons 
of old. The actual control over affairs exercised by some of 
these modern barons of business and the possibilities of power 
through modern forms of business organization are far from be- 
ing realized by the general public. Though business and big 
business in particular is apt to chafe at any measure of regula- 
tion, it is conservatively evident considering the monopolistic 
nature of the powers exercised, that some regulation is for the 
general good. But whatever governmental control over private 
enterprise is exerted its purpose should be to regulate and not 
to restrict. Considering the important part played by enterprise 
in developing the resources of the nation and directing its busi- 
ness activities, to cripple it or even to hobble it with unneces- 
sary legal restrictions would be detrimental to the welfare of 
the country. Any such control that results in preventing the 
organization or extension of business enterprises depresses busi- 
ness and not only lessens profits but reduces the other shares in 
the bargain. 



PROFIT 377 

In the field of business the call for leaders is as urgent today 
as ever and the opportunities are as great. In comparison with 
the old world this . country is still undeveloped. In no other 
nation is it so easily possible for any man to launch out for 
himself. In the race of the nations the United States has a 
flying start, with a national wealth estimated at $350,000,000,- 
000, over $230,000,000,000 more than that of the United King- 
dom. It has the raw materials; it is no longer handicapped for 
capital; it has the skilled and unskilled labor and as finely or- 
ganized a body of going concerns as any nation in existence. 
With the advance of progress there are always new fields of en- 
terprise opening up. The bulk of the large industries of the 
past have been tied down to the earth in the development of its 
denser materials ; science and invention are opening up the realm 
of the air. Synthetic chemistry introduces still another field 
pregnant with profitable opportunities for private enterprise. 
Science and invention are the pioneers, the discoverers ; enterprise 
follows hard at their heels, to make the possibilities they reveal 
realities for the use of all. Today science seems to be leading 
us across the threshold of a new era of industrial development, — 
an era that promises to be packed with opportunities for those 
who would steer the bolder course, who are willing and able to 
undertake the risk and responsibility of leadership, who have 
the vision to see, the brains to plan, and the ability to forge the 
factors of industry into productive shape. 

THE DIFFICULTY OF GAUGING PROFIT 

Of all the shares of distribution profit is the most private. In 
the case of a competitive enterprise it is perfectly natural for the 
concern to wish to keep its profits to itself, and there are good 
reasons from a business standpoint why it should. In the case 
of a public utility company or a monopoly the wish to keep the 
extent of their profit strictly private is also natural ; but there are 
excellent reasons why the profits of these concerns should be ac- 
curately gauged and available to the inspection of Federal or 
state commissions or other properly appointed persons. The de- 
sire for privacy in regard to profit by no means always springs 
from dishonest motives nor are expedients used to conceal profits 



378 PRACTICAL ECONOMICS 

necessarily bad. But they make it extremely difficult to ascertain 
with any accuracy the extent of profits and often make it ex- 
tremely easy to conceal profits for fraudulent purposes. Nom- 
inal profits are far from being real profits. 

Overvaluation of purchases, undervaluation of inventories, 
excessive depreciation rates, charging capital goods to expense, 
watering of stock, are perhaps the most common devices used to 
conceal profit. Some of these, as inflated purchase prices of sup- 
plies, are plainly criminal, others such as the diversion of what 
otherwise would be profits into apparently excessive salaries 
or stock-watering, may or may not be justifiable expedients. In 
the case of a partnership it might be a matter of indifference 
whether the earnings were distributed in the form of profits or 
paid as salaries. In a close corporation it might make little 
difference except as a ruse to dodge the income tax. If, however, 
a clique gains control of a large corporation and uses the oppor- 
tunity to pay themselves and their friends excessive salaries, it 
would be a filching of funds properly belonging to the other 
stockholders. 

STOCK-WATERING AND OVERCAPITALIZATION 

Perhaps the most popular, at any rate the most widely known 
and condemned device for concealing corporation profits is stock- 
watering. The term is said to have originated from the practice 
of the old cattle men who in driving their herds to New York 
over the Jersey swamps fed them with salt; the thirsty kine then 
imbibed so much water on their way to market that their weight 
was materially increased. In reference to corporations, stock- 
watering consists in increasing capitalization by overvaluing 
present assets and issuing new securities based on this over- 
valuation ; this lowers the dividend rate by spreading earnings of 
actual assets over a larger amount of outstanding stock. The 
ease with which excessive profits are concealed by this process 
is obvious. The same net earnings distributed over a larger 
capitalization- mean a lower dividend rate. Suppose that after 
paying the usual 7 per cent on preferred, the balance of net 
earnings to be distributed among the holders of $1,000,000 com- 
mon stock was $200,000, which represents a dividend rate of 20 



PROFIT 379 

per cent. The same net earnings distributed over $2,000,000 com- 
mon stock would mean but a 10 per cent dividend. A going con- 
cern wishing to conceal unusually large earnings, may by a 
revaluation of its capital assets satisfy the proper authorities of 
its right to increase its capitalization, issue new securities, sell 
or distribute them among its stockholders in the form of a stock 
dividend. Its dividend rate thereafter on the increased capitali- 
zation will be but normal. In the case of a new corporation or 
a reorganization with large anticipated earnings the capitali- 
zation will be so adjusted as to permit the payment of dividends 
at the current rate. To go into details here would bring us into 
the realm of corporation finance, a most fascinating subject, for 
light on which the reader is referred to W. H. Walker's excellent 
and practical treatise. 

Stock-watering is one method of overcapitalization. It is 
deliberate overcapitalization, and as such it is an evil practice. 
But it is doubtful whether all that is called stock-watering is in 
reality watering. In many cases the capitalization is but brought 
up to its proper figure. Take the classic example of the United 
States Steel Corporation, which is said to have been "watered" 
to the tune of $550,000,000. In this transaction $550,000,000 
preferred and $550,000,000 common stock of the steel corporation 
plus $304,000,000 of its bonds were delivered to the promoting 
syndicate in exchange for the capital stock of the ten constituent 
steel companies, plus $25,000,000 in cash. The assumption is 
that the securities of the old companies represented the value of 
their capital assets and that the new corporation issued capital 
stock $550,000,000 in excess of the valuation of the properties 
of the old companies. The steel corporation claimed that the 
$550,000,000 represented the capitalized value of the economies 
made possible by the new corporation. The earnings of the 
corporation since have justified this claim. The new corpora- 
tion was a more productive organization than were previously 
the ten old companies. The extra capital stock issued did not 
overvalue the productive power of the new corporation. It did 
mean tremendous profits to all those involved directly or 
indirectly in its organization. But those who conceived and 
carried out the reorganization created a tremendously efficient 



380 PRACTICAL ECONOMICS 

production unit. Their profits were huge but so was the 
organization they brought into being. 

One of the most prolific causes of stock- watering, real and 
supposed, is to obtain the profits of promotion. When a business 
is overcapitalized for this purpose through malice aforethought it 
is of course criminal. But the organization or reorganization of 
corporations is by no means a light task, often a colossal one, 
and those who are able to carry it out must be paid for it. 
And it is usually better that they should be paid in stock of the 
companies they aid in forming as this tends to fix responsibility 
where responsibility belongs, for a time at least. But whether 
paid in cash or stock the amount of their payment should be 
based on the cost of their exertions on the one side and the 
productivity of the organization they bring into being on the 
other. Both of these are difficult to estimate, productivity is a 
thing of the future. Both are apt to be overestimated through 
self-interest or optimism. Nevertheless the elimination of such 
profit or its too rigid curtailment would no doubt discourage the 
organization of new enterprises and lead to depression. 

The capitalization of a corporation represents or should repre- 
sent its value as a factor in production. There is a considerable 
difference in practice and a, still greater disagreement in theory 
as to the basis on which the valuation of a corporation should 
take place. The four bases of valuation are: original cost of 
assets, cost of reproduction or replacement and earning power. 
There is a tendency in theory to base value on cost alone and 
disregard productivity. But the value of a corporation like that 
of a machine or a building depends not only on cost but also on 
productivity. No matter what a machine has cost, no matter 
how valuable the materials of which it is conducted, if it can- 
not be put to a productive use it is of little value. Similarly 
with a corporation, no matter how costly its assets, no matter 
what its land, buildings, equipment, materials, patents, trade- 
marks, services entering into its construction have cost, it is of 
little value unless it is able to produce its commodity or service 
at a price that will bring at least a profit that will cover its cost 
of operation. The corporation itself, distinct from its constitu- 



PROFIT 381 

ent parts, has a value as a productive unit. In actual practice 
earning power is the basis of valuation and the business world 
is justified in taking it into consideration. The valuation of a 
corporation should rest on both cost and productivity. But 
whate/er the basis of valuation it will always be a matter of 
very uncertain estimate. The value of the capital assets of a 
business, especially of its intangible assets, is a matter 
of conjecture. It is in connection with these intangible assets 
that overvaluation frequently occurs, yet they are often the 
most valuable. Moreover, the assets change rapidly, either ap- 
preciating or deteriorating. Even if the capitalization of a cor- 
poration is equivalent to the value of its assets at its inception 
there is no guarantee that they will remain so. Should they 
appreciate the concern will be undercapitalized ; should they de- 
teriorate it will be overcapitalized. Capitalization is thus a very 
elusive thing and it is difficult to tell whether watering has oc- 
curred or not. Fraudulent valuation is remarkably easy and 
overcapitalization is too common, as a glance at the quotations 
on the great exchanges show. The market price of a stock is 
generally speaking a pretty fair test of its value and the large 
number of stocks selling below par is an indication of the preva- 
lence of overcapitalization. There is need for great conser- 
vatism. Better accounting methods, more publicity in regard to 
the details of promotion and organization of new enterprises 
and reorganizations, a more rigid governmental control in the 
issue of new securities, the removal of par value from common 
stock certificates, these will materially aid not only in preventing 
fraud but in reducing overcapitalization in general. 

TEST QUESTIONS 

1. What is profit? 

2. Why is the payment of profit essential in our economic system 
today? 

3. What is the relation between risk and responsibihty to profit? 

4. What function does profit perform in industry? 

5. Mention some of the quahties on which the entrepreneur's abihty 
depends. 

6. Name some of the expedients used to conceal profits. 

7. What are the bases for the valuation of corporation assets? 



382 PRACTICAL ECONOMICS 

REFERENCES 

Carver, T. N., Principles of Political Economy (Chap. 37). 

Clark, J. B., The Distribution of Wealth. 

Clay, H., Economics for the General Reader (Chap. XVIII). 

Fetter, F. A., Economic Principles (Part 5). 

Friday, D., Profits, Wages and Prices. 

Hadley, a. T., Economics (Chaps. IV, IX). 

Hawley, F. B., Enterprise and the Productive Process. 

Marshall, A., Principles of Economics (Book 6, Chaps. VI to VII). 

Marshall and Lyon, Our Economic Organization. 

Nicholson, J. S., Principles of Pohtical Economy (Book 2, Chap. XIII 

and Book 4, Chap. VI). 
Seager, H. R., Principles of Economics (Chaps. XII, XIII). 
Seligmaist, E. R. a.. Principles of Economics (Chap. XXIII). 
Taussig, F. W., Principles of Economics (Chaps. XLVIII to L). 
Veblen, T. B., Theory of Business Enterprise. 
Watkins, G. p., The Growth of Large Fortunes. 



INDEX 



Academic education, relation to busi- 
ness success, 347. 

Advertising, growth, 161; cost, 161; 
economy of, as a method of mar- 
keting, 160-163; criticism of, 164; 
services, 165. 

Alexander Hamilton Institute, 160. 

American Cigar Stores Co., 310. 

Arkwright, Richard, 57. 

Asbestos Textile Manufacturers As- 
sociation, 205. 

Astor, John Jacob, 318. 



B 



Bank notes, 234, 235. 

Bank reserves, 248. 

Banking, how banks create credit, 
243; how they provide a medium 
of exchange, 245; clearing house 
operations, 247; reserves, 248; 
Federal Reserve Act, 251; liquid 
assets, 252; rediscounting, 253; 
loans, 252; growth and present 
strength of, in U. S., 254. 

Banking power of U. S., 254. 

Basset, WiUiam R., 161. 

Bell, G., 375. 

Bills of exchange, 282. 

BimetalHsm, 237. 

Birth rate, influenced by standard of 
living, 337; declining in France, 
339; in U. S., 339; birth chart 
of principal nations, 341. 

Bohm-Bawerk, 66. 

Bureau of Labor Statistics, index 
number, 268. 



Business associations, 204. 
Business enterprise in U. S., 374. 
Business failures, 372. 
By-products, savings in large-scale 
organization, 113. 



C 



Cahfornia Association Raisin Co., 
162. 

California Fruit Growers Exchange, 
161. 

Capital, see contents chs. VI, VII, 
XXVIII; derived nature, 64; 
definitions, 65-67; category of 
capital goods, 67; fixed and cir- 
culating, 68; production of, 70; 
maintenance of, 72; functions of, 
74; evolution of, 74; how it in- 
creases production, 77; as a store 
of wealth, 80; growth of, in U. S., 
81; relation to labor, 82; inter- 
national flow of, 286. 

Capital assets, 380. 

CapitaUzation, 378. 

CarU, 260. 

Carnegie, Andrew, letters, 101. 

Cartwright, Edmund, 57. 

CentraHzation of control, 88. 

City and store sites, value of, 309. 

Clay, Henry, 65, 349. 

Coal supply of the United States, 21; 
27. 

Coinage, 227; free, 228. 

Combination, kinds of, 97; in steel 
industry, 98; causes, 101. 

Competition, cause of combination, 
101; internal, 110. 

Consumption goods, 67, 299. 

Cooperative Competition Idea, 205. 



383 



384 



INDEX 



Corporations, how created, advan- 
tages and disadvantages, 91; in- 
ternal organization, 92; evolu- 
tion of, 96; nunaber of, in U. S., 
96; capitalization, 378; basis of 
valuation of assets, 379. 

Cost, meaning of, 169; real cost, 170; 
relation to supply price of land, 
172; analysis of manufacturing 
cost, 174; joint cost, 177; influ- 
ence of cost on supply price, ch. 
XVI; law of increasing cost, 181; 
of decreasing cost, 185; constant 
cost, 188; relation to utility, 192. 

Credit, bank, 242. 

Crompton, S., 57. 

Currency, defined, 241. 



D 



Darwin, Charles E., 349. 

Death rates in principal nations, 336. 

Demand, see contents, chs. XIII, 
XIV; meaning of, 127; sched- 
ules, 128; law of, 129; elasticity 
of, 129; forces behind, 148; de- 
terminants of individual de- 
mand, 139; influence of mar- 
ginal utihty on, 142; law of, ex- 
plained, 157; factors of demand, 
157; creation of, 160. 

Demand and Supply, see contents, 
chs. XII-XIX; law of, 127; op- 
eration illustrated, 130; forces 
underlying law, 192; under com- 
petition, 217; influenced by mo- 
nopoly, 218; relation to price 
control, 220. 

Density of population, 343. 

Deposit currency, see contents, ch. 
XXI; nature, 241; origin, 243; 
as a medium of exchange, 245; 
how secured, 248. 

Depreciated currency, effect on rate 
of exchange, 288. 

Destructive competition, in steel in- 
dustry^ 101. 



Diminishing productivity, law of, 300. 

Diminishing returns, law of, 181, 
300. 

Diminishing utiHty, law of, 139. 

Discount rate and rate of exchange, 
286. 

Distribution of wealth, see contents 
ch. XXIV; survey of, in U. S., 
293; law governing, 298. 

Division of labor, see contents ch. V; 
development of, 50; in scientific 
management, 51; law of organic 
development, 52; simple and 
complex, 53; ways in which it 
increases production, 55; disad- 
vantages, 58; relation to mar- 
kets, 59; geographical, 60; in 
higher orders of abiUty, 110; re- 
lation to exchange and value, 
117. 



E 



Economic system, 4. 

Economics, see contents ch. I; defi- 
nition, 3, 6; relation to special- 
ized business sciences, 5; meth- 
ods, 6; laws of, 7; values, 9. 

Education and training, 346. 

Emerson efficiency system, 324. 

England and Wales, birth rate, 339. 



F 



Factors of production, 15; value of, 

298, 305. 
Factory sites, factors influencing 

value, 309. 
Farm lands, factors influencing value, 

308. 
Favorable balance of trade, 286. 
Federal Reserve Act, 251. 
Federal Reserve Notes, 235. 
Federal Trade Commission, 205. 
FertiHty, 308. 
Finance bills, 286. 
Foreign exchange, 281. 



INDEX 



385 



forests, depletion of, in U. S., 19. 
Friday, D., 357. 



G 



Gantt, task and bonus plan, 324. 

Gary, Judge, 108. 

George, Henry, 312. 

Gold, as standard money, 225, 227; 
sovereign, 228; dollar, 228; stock 
of gold coin and bullion in U. S., 
231; gold standard act, 236; cer- 
tificates, 232; influence on prices, 
278; influence on rate of foreign 
exchange, 285. 

Gold points, 281. 

Governmental price control, 220. 

Governmental regulation of industry, 
376. 

Greenbacks, 234. 

Gresham's Law, 238. 



H 



Halsey premium plan, 323. 
Hamilton, Alexander, stand against 

error of Physiocrats, 16; Report 

on Manufactures, 17. 
Hargreaves, J., 57. 
Havemeyer, H. O., 107. 
Hill, James J., 362. 
Holding Company, 96. 
Housewives services, value, 297. 



Index numbers, purpose, 260; selec- 
tion of commodities for, 260; 
price data, 262; methods of com- 
puting, 263; weighted, 266; Hst 
of, in U. S., 268; wholesale prices 
in U. S., 268; retail price index, 
269. 

Integration, 97; economy of, 109. 

Intellectual processes, 45. 

Intensive cultivation, furthered by 
Department of Agriculture, 20. 

Interest defined, 355; depending on 
supply of loanable funds, 355; 
forces determining rate of, on 
demand side, 362; influence of 
risk, 366. 

"Invisible" balance of trade, 284. 

Iron resources of U. S., 24. 



James, William, 66. 
Jevons, W. S., 66. 
Johnson, Joseph French, 357. 
Joint product, how to determine 
value of a factor of, 299. 



K 



King, W. I., 293. 
Kleinewachter, 65. 
Knauth, 293. 



Immigration, 343. 

Income, survey of, in U. S., 293; rela- 
tive shares of labor and capital, 
295; wages 1913, 1918, in U. S., 
295; income tax returns, 1918, 
159; incomes above and below 
$2,000, 295; growth of national 
income, 297; incomes of chief 
nations, 297. 

Incomes, table of incomes in U. S. for 
1918, 159. 



Labor, four parts played by, 32; of 
pure science, 32; of invention, 
34; of organization and manage- 
ment, 36; direct, 37; efficiency of, 
see contents, ch. IV; relation to 
capital, 82; relation to value, 121; 
see also Man. 

Labor organization, 350. 

Land, causes of productivity, 308; 
marginal land, 308; value of 
farm, city and store sites, 308; 



386 



INDEX 



unique conditions of supply of, 
311; tendency of land values to 
rise, 315; nationalization of, 317; 
taxation of, 318; see also nature. 

Large-scale organization, develop- 
ment of, 96; forms of, 96; in steel 
industry, 98; causes, 101; eco- 
nomics of, ch. XIX. 

Leadership, qualities of, 374. 

Legal tender, defined, 227. 

Location, influence on value of land, 
308. 

Localization of industries, 60. 



M 



Machinery, evolution of, 74; how it 
increases production, 77; future 
of, 79; speciahzed, 106; relation 
to labor, 331. 

McLeod, 66. 

Malthus, theory of population, 334. 

Man as a factor in production, see 
contents, ch. Ill; functions of, 
38; quahties determining effi- 
ciency; see contents, ch. IV; see 
also wages. 

Manhattan Island, purchase, 318. 

Margin of production, 308. 

Marginal productivity, 301. 

Marginal utiHty, 140; relation to de- 
mand, 141; relation to price, 156. 

Marx, K., 122. 

Maudslay, Henry, 78. 

Maximum gain, 146. 

Mendel, 349. 

Mental energy, 44. 

Merger, 96. 

Mickelberry, W., 162. 

Mill, John Stuart, 318. 

Minuit, Peter, 318. 

Money, see contents, chs. XX, XXI; 
relation to wealth, 223; func- 
tions, 224; quahties, 224; fiat 
money, 225; relation of govern- 
ment to, 226; standard, 228; 
supplementary, 229; token, 230; 



kinds of money in U. S., 230' 
gold bases, 236; legal tender, 227; 
Gresham's Law, 238; quantity 
theory of money, 277; influence 
of supply of money on price 
level, 276. 

Monopoly, see contents, ch. XVIII; 
nature of, 204; control through 
business associations, 204; pools, 
206; selling organizations, 208; 
power over price illustrated, 211; 
law of monopoly price, 212; 
under decreasing cost, 212; rela- 
tion of elasticity of demand to, 
213; hmitations to, 214; monop- 
oly price, 215, 218; the unorgan- 
ized consumer, 219. 

Morgan, 375. 



N 



National banking system, 251. 

National Bureau of Economic Re- 
search, 293. 

National Cash Register Co., 160. 

Nationalization of land, 318. 

Natural resources, see contents, ch. 
II; conservation of, 18; striking 
facts in reference to, 25; survey 
of, in U. S., 26. 

Natural ability, limiting supply of 
labor, 345. 

Nature, see contents, ch. II; functions 
performed in production, 15; re- 
lation to Nation's industries, 17; 
relation of science to, 26. 



O 



Open Price Idea, 205. 

Organization, see contents, chs. VIII, 
IX, X; as a factor in production, 
84; defined, 85; essential fea- 
tures, 85; forms of, 89; evolution 
of; large-scale, 98. 

Overcapitalization, 378. 



INDEX 



387 



Par of exchange, 281. 

Partnership, 90. 

Personal character traits influencing 
economic efficiency, 47. 

Physical fitness, 43. 

Physiocrats, 16. 

Piecework, 322. 

Pittsburgh, 309. 

Pools, and gentlemen's agreements, 
206; rail, 103. 

Population, Malthusian theory of, 
334; positive checks to, 335; 
death rates of leading nations, 
336; voluntary control, 337; 
chart showing increase in popu- 
lation of leading nations, 338; 
birth chart of principal nations, 
341; dechning birth rate of 
France, 339; modern tendency, 
341; growth of population in 
U. S., 343; external growth of, 
343; density of, 343. 

Power, concentration of, 376. 

Price, defined, 123; as a measure of 
value, 124; equiUbrium price, 
132; demand price, 157; supply 
price, 180; influence of cost on 
price, 190; influence of monop- 
oly on price, ch. XVIII; com- 
petitive price, 221; regulation of, 
220; variations from market, 
194; price poHcies, 194; influ- 
ence of utihty and cost on, 197; 
buyer's influence on, 197; influ- 
ence of sellers on, 199; open price 
idea, 205. 
Price changes, see contents, chs. 
XXII, XXIII; relation to value 
of money, 123, 259; general level 
of prices, 260; measurement of, 
by index numbers, 260; con- 
struction of index numbers, 260- 
267; wholesale prices in U. S., 
267; retail prices, 269; causes of, 
276; influence of the supply of 



money on, 276; influence of 
volume of trade on, 278; effects 
of, 279; relative prices, 264. 

Private ownership of land, 317. 

Production good, 299. 

Production of wealth, chs. II-X. 

Productivity of factor of production, 
298. 

Profit, definition of, 368; relation to 
business enterprise, 370; the jus- 
tification of, 371; business fail- 
ures, 372; relation of monopoly 
to, 373; function of, 373; diffi- 
culty of measuring, 377; promo- 
tion profits, 380. 

Profits, in reorganizations, 103. 

Psychology, aid in analyzing and 
measuring human abiUty, 41. 

Purchasing, economies in, 106. 



R 



Real cost, 170; how converted into 
money cost, 191; relation to sup- 
ply price of land, 172. 

Real wages, 326. 

Rediscounting, defined, 253. 

Rent, definition, 306; commercial and 
economic rent, 306; as a surplus, 
307; influence of productivity of 
land on, 308; influence of con- 
ditions of supply of land on, 311; 
nature of, illustrated, 312; ten- 
dency of land values to rise, 315; 
relation of rent to wages, inter- 
est and profits, 316; ethics of, 
317. 

Ricardo, D., 122. 

Risk in business enterprise, 391. 

Roberts, Percival, 98. 

Rothamsted Experimental Farm, 301. 



S 



Sales efficiency, in large-scale organi- 
zation, 111. 



388 



INDEX 



Saving in modern society, 71; in ref- 
erence to the supply of capital, 
357; amount in U. S., 357; fac- 
tors determining, 357-362. 

Schwab, Charles, 108, 110. 

"Scientific management," relation to 
division of labor, 58. 

Shakespeare, 330. 

Silver, dollar, 232; certificates, 233. 

Smith, Adam, 5, 349. 

Social environment, influence on busi- 
ness success, 348. 

Soil exhaustion, 20. 

Sole proprietorship, 89. 

SpeciaUzation, dangers of, 58; rela- 
tion to organization, 87; plant, 
107. 

Standard of living, 337. 

Standardization, of methods, 108. 

Steel industry, combination in, 98; 
destructive competition, 101; re- 
organization profits, 103; spe- 
cialized machinery, 107; corpor- 
ations, 103; integration, 109. 

Steinmetz, Charles P., 80. 

Sterling exchange, 283; rate, 284. 

Stock inflation in steel industry, 
103. 

Stockwatering, 378. 

Stone, N. I., 330. 

Stone & Webster Co., 375. 

Supply, see contents, chs. XV, XVI; 
schedules, 130; determinants of, 
168; influence of cost on, 190; 
law of increasing cost, 181; law 
of decreasing cost, 186; control 
of, see monopoly. 



Trade acceptance, 252. 

Taussig, 349. 

Taylor, Frederick W., system of Sci- 
entific Management, 51; scien- 
tific division of task, 56; differ- 
ential piece-rate system, 324. 

Taxation of land, 318. 



U 



Unearned increment, 318. 

United States Steel Corporation, 98; 
reorganization profits, 103; com- 
parative cost statements, 110. 

Utility, relation to value, 119; rela- 
tion to demand, 139; diminish- 
ing, 139; marginal, 140; of 
money, 149. 



Value, see contents, ch. XI; relation 
of exchange to, 117; relation to 
distribution, 117, 298; relation to 
utiUty, 119; origin of, 120; basic 
elements, 121; relation of labor 
to, 121; price and, 123. 

Value product, defined, 293. 

Voluntary control of birth rate, 337. 



W 



Wage systems, 321. 

Wages, see contents chs. XXVI, 
XXVII; defined, 320; methods of 
payment, 321; money and real 
wages, 325; influenced by rising 
and falling prices, 326; iron law 
of, 328; factors influencing, 328; 
efficiency and, 329; influence of 
other productive factors on, 330; 
effect of machinery on, 331; pop- 
ulation and, 337; influence of 
standard of living on, 337; influ- 
ence of abiUty, education and 
social environment on, 345; 
wages and salaries in U. S., 1913, 
18, 295; per cent of total paid to 
salaried officials, 295; organized 
control of demand and supply of 
labor, 305. 

Watt, J., 57. 

Wealth of U. S., 375. 

Webb bill, 112. 

Westinghouse, G., 375. 

Whitney, EH, 78. 



